Here's an interesting "big picture" article from the WSJ:
July 6, 1999
This Boom, Some Say, Is on the House;
Family Homes Fund U.S. Spending Spree
By TRISTAN MABRY
Staff Reporter of THE WALL STREET JOURNAL
NEW YORK -- What is driving the consumer spending spree that has
powered economic growth?
Many economists point to the long-running stock-market rally which has
created more than $10 trillion in wealth over the past 10 years and
triggered what economists call a "wealth effect." Rising asset prices, the
theory goes, make people feel rich, so they spend lavishly and boost
economic growth.
But some economists now believe that the economy is being supported not
by the enormous wealth on paper but by the more modest wealth on dirt:
the concrete, bricks and timber of the family home.
"There is some evidence that at very high income levels, the top 3%, there
is a wealth effect from the stock market. That's why Tiffany's is doing so
well and why boat sales are rising. But that's not what Middle America is
responding to," says Diane Swonk, a senior economist at Bank One Corp.
"Middle America is responding to the robust appreciation in home values,
and they are cashing in by restructuring their mortgages."
It is easy to understand why. The National Association of Realtors
estimates the median value of a single-family home has risen 50% over the
past 10 years to about $133,100.
Accumulated stock-market wealth, of course, is much larger and has risen
faster. But it is also concentrated in far fewer hands, while over two-thirds
of American families live in homes they own. According to one estimate,
by New York University economics professor Edward N. Wolff, the top
10% of households own 88% of stocks and mutual funds.
'Too Much' Market Focus
Maureen Allyn, chief economist at Scudder Kemper Investments Inc.,
agrees. "We focus on the stock market too much," she says. "The stock
market does add to the confidence that consumers are feeling but it's the
ability to tap the money that comes out of your home" which provides the
dollars that fuel consumer spending.
So much so, that the family home is becoming a cash cow for consumer
purchasing power. The Joint Center for Housing Studies of Harvard
University found that heavy refinancing and other activity last year pumped
hundreds of billions of dollars into the economy, by allowing homeowners
to borrow against their home equity and by freeing up cash through lower
mortgage payments. But it has taken economists a while to recognize this
real-estate wealth effect, because no one group provides statistics that
capture the full picture.
The Federal Reserve estimates that since 1995, home sales have yielded
an average of about $35,000 in capital gains for a total economic impact
of $150 billion annually. And the effect of those dollars has been amplified
since 1997, when a new tax law sheltered the first $500,000 of capital
gains made on the sale of a married couple's primary residence.
In addition, Bank One estimates that "cash out" refinancing, where home
owners get cash upfront in exchange for a bigger mortgage, contributed
about $60 billion in extra income for consumers last year. Bank One
derived that number using data from a recent study by mortgage lender
Freddie Mac, which found that 51% of borrowers who refinanced in 1998
pulled out an average of 11% of their homes' equity.
Home-equity borrowing, including lines of credit and second mortgages,
has been steadily rising for years and jumped $73 billion in 1997 to $420
billion, according to the Fed. Meanwhile, monthly mortgage payments
have dropped in real terms over the past 10 years by 19% to $681 in
1998, down from $840 in 1989, according to the Harvard study, saving
consumers about $2 billion a year.
Not all of that money is available for spending, but economists believe a
large amount of it is spent and very little is saved. "Do they save it? No.
They buy cars, they add on to their homes, they find a multitude of ways to
spend," says Ms. Swonk.
Consider the case of Larry Nutter, retired last year after more than three
decades at defense contractor Lockheed Martin Corp. The 57-year-old
says his "nice retirement" is already secure thanks to the benefits provided
by his former employer. But Mr. Nutter wants more than just security: He
wants a vineyard.
"Growing Zinfandel and San Giovese grapes," said Mr. Nutter, is a dream
the former Trident missile specialist can more easily afford thanks to his
home in San Jose, Calif., which rose in value to $450,000 today from
$59,000 in 1979. Mr. Nutter plans to sell the house next year and spend
some of the proceeds on his new hobby.
Counters and Cabinets
For Bill Fitzgerald and Amy Dalton, the best part about cash-out
refinancing is "granite counters and cherry cabinets." In 1995, Mr.
Fitzgerald bought a small Manhattan apartment for about $250,000 with a
30-year, fixed-rate mortgage at 8 3/4%. In 1998, the young couple
refinanced with an adjustable-rate mortgage at 6 3/4 %, sharply cutting
their interest costs. At the same time, and without raising their monthly
mortgage payment, they raised their principal debt to borrow an extra
$25,000. The money was used to pay for remodeling work on their
apartment, including a new kitchen, a new bathroom and a dividing wall.
The question remains, however, which wealth effect would be more sorely
missed by the broader economy, stocks or real estate?
"If you envision a world where stocks take a big hit, it's quite likely to be a
world with rising interest rates," said Robert J. Barbera, chief economist at
Hoenig & Co. Inc. "Say the second half of this year involves a large rate
rise and a market decline, then you're in a situation where the wealth effect
from both stocks and refinancings goes to zero." |
