Consumer spending and the housing market

Recent days have produced a flurry of info on the housing market's effect on the overall economy, and, most importantly, on consumer spending.

The Federal reserve web site posted a research paper by Alan Greenspan and James Kennedy on the effect that cashouts, refinancings, etc. of home equity have had on consumer spending. It is a very dense paper, but the highlights as reported by Bloomberg are that extraction of home equity financed 2.9% of overall consumer spending from 2001-05 compared with 1.1% from 1991-2000.

Already there is talk by industry types that the current housing weakness is having an impact on spending in the economy of both the U.S. and foreign countries where remittences from the U.S. play a big economic role (like Mexico).

To give you an idea of how much spending has been financed by home equity, consider that consumer spending was pegged at $7,057.60 (in billions) for Q3 of 2001 by the Bureau of Economic Analysis. 3% of that would b more than $220 billion.

And keep in mind that home equity can also indirectly finance consumer spending. While some homeowners may draw down their equity to get cash, other simply run up credit cards or other debt, knowing they have their home equity in reserve to help pay off the bill.

A home is a home is a home; so let's buy the cheaper one

This is probably one result of the foreclosure crisis in sub-prime mortgages, and it sure is interesting: Sales of newly built homes fell by the same exact percentage (3.9%) as sales of existing homes rose, according to Forbes Magazine.

The explanation (a.k.a. "let's take a stab at it"):

David Lereah, the head economist for the National Association of Realtors, said the landscape for the resale market is very different from new-home sales. “There is a recovery in existing home sales, but for new home builders, the market will be very bumpy going forward,” he said. “New-home sales are still in recession, and increased foreclosures and subprime problems will make the next two years difficult.”

New foreclosures and tightening credit standards will lead to a glut in housing and limit potential buyers. According to the report, the number of unsold homes rose to its highest level in 16 years, indicating that prices for new homes will continue to fall as competition tightens.

At the end of February, there were 546,000 houses on the market, translating to an 8.1 months supply— the highest backlog since January 1991.

Calling the subprime crunch “a real negative,” Lereah said from 10% to 25% of subprime borrowers, about 100,000 to 250,000 potential home buyers, will no longer be able to qualify for loans. This is bound to affect prime borrowers, who may postpone purchases because of tighter lending practices, he said. However, the ongoing price correction and low mortgage rates should continue to lure new home buyers and the long-term fundamentals remain solid, Lereah said.

In short, sales of existing homes don't help the construction industry, but sales of new homes do.