Housing wealth and macro-economy

Housing wealth impacts significantly the macro-economy

Low level of long-term interest rates is an incentive for cash-out refinancings
and, therefore, for consumer spending.

The housing market impacts the macro economy through many channels, most directly through construction jobs and homebuilding activity, and spending on furniture and appliances by families moving into new or existing homes. No channel has been more important of late than housing wealth.

According to many prominent economists, the extraction of home equity wealth in recent years has propped up consumer spending. A sudden swoon in housing prices, they warn, could shut off this spigot, prompting a sharp cutback in spending and elevating recession risks.

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Growth of house prices has indisputably stalled, and even reversed in some parts of the country. Price appreciation on a year-ago change basis slowed from rates exceeding 13 percent in 2005, to 6 percent by the fourth quarter of 2006.

More recent monthly data show prices flat or falling in many major cities. Such weakness has fueled fears that an abrupt halt to growth of housing wealth may limit households' ability to withdraw home equity. Such a decline in cash-out refinancings could, in turn, undermine consumer spending.

Reports on mortgage applications and cash-out refinancings provide important and perhaps surprising news. The refinance share of mortgage applications averaged 46 percent in the first quarter of 2007, unchanged from the prior period. Moreover, homeowners continued to extract home equity in the first quarter at close to the pace of late last year, despite diminished price appreciation.

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In particular, 82 percent of loans refinanced during the first quarter resulted in a new loan balance at least 5 percent greater than the unpaid balance of the original loan, with an estimated $70.5 billion cashed out, only slightly below the $77.0 billion cashed out in the fourth quarter of 2006.

There are several reasons why cash-outs have defied reports of their demise. Most importantly, the current rate of housing price appreciation is not what determines if a cash-out is feasible, but rather the cumulative gain since the existing loan was originated.

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Homeowners have benefited from robust price gains during 2004 and 2005. As a result, the median appreciation on refinanced properties was 24 percent, providing ample margin for taking out cash without running down home equity. The low level of long-term interest rates provides another incentive for cash-out refinancings.

Rates on 30-year fixed-rate mortgages averaged 6.2 percent in the first quarter, allowing many homeowners to use the proceeds to pay off higher-cost credit card debts or home equity lines. With mortgage rates stable in our economic forecast, we anticipate that refinancing activity will wane only gradually.

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There are still legitimate concerns that a high level of cash-outs may deplete homeowners' equity in their properties. However, homeowners' equity had grown to nearly $11 trillion at the end of 2006, an increase of 30 percent over the past three years, even after cash-out activity.

The housing market recovery still faces significant risks, to be sure, in particular the danger that problems in the subprime space spill over to mortgage markets in general, inflicting damage on the macro economy.

Continued smooth performance of the mortgage markets will be a critical factor supporting the housing recovery in the months ahead.


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