Housing’s wealth effect to nudge U.S. spending

For the first time since the recession, there’s potential for rising U.S. property values to boost consumer spending and give the economy a nudge.

Housing’s so-called wealth effect has been a drag on household purchases since 2008. A projected 2% gain in home values next year will start to lift consumer spending in the second half of 2013, according to Michelle Meyer, senior economist at Bank of America Corp. in New York.

Meyer predicts the wealth effect will add 0.1 percentage point to spending per quarter, swinging from a 0.9 percentage point drag at the height of the housing crisis in the first quarter of 2009. The contribution represents a long-awaited turning point at a time when a struggling labor market impedes wage growth and manufacturing provides less support for the three-year expansion.

“There are a lot of encouraging signs in the housing market,” Meyer said. “It will still be a gradual recovery unless you see the overall economy turn stronger, but price data continues to come in strong even into the summer and early fall. I definitely have gotten more convinced of the turn in housing.”

Home prices in the second quarter increased 2.2% from the previous three months, the best performance since the fourth quarter of 2005, according to S&P/Case-Shiller data. The lowest mortgage rates on record, a smaller inventory of available homes and a drop in distressed property sales have fostered the pickup.

BUILDER CONFIDENCE
Adding to signs of a recovery: confidence among U.S. homebuilders climbed in September to the highest level in more than six years, according to the National Association of Home Builders/Wells Fargo builder sentiment index released today (Sept. 18).

CoreLogic Inc. said last week that single-family home values in the U.S. climbed 3.8% in July from a year earlier, the biggest 12-month gain since August 2006. Prices last quarter posted their first year-over-year increase since 2007, according to Zillow Inc., the Seattle-based operator of the largest real-estate information website.

Rising home values stimulate household spending through a channel economists call the wealth effect, which posits that homeowners lift spending in proportion to anticipated changes in wealth over time. A common rule of thumb is that for every dollar increase in housing wealth, consumers will purchase an average of 4 cents more, according to Meyer.

The impact is widespread because of the role homes play in Americans’ portfolios.

Primary residences accounted for 30% of total family assets in 2010, making housing “of greater importance than financial assets for the wealth position of most families,” Federal Reserve researchers wrote in June using the most current data. About 66% of U.S. homes were occupied by their owner – as opposed to renters – in the second quarter, Census Bureau data show.

SPENDING LAG
At the same time, it will take time for the full impact of the recovery in housing to show up in consumer spending. Rising home prices spur spending with a lag, meaning the wealth effect won’t show up this year, Meyer said.

Another indication of the scope of the price gains: more than 1.3 million homeowners regained equity in their properties in the first six months of this year, according to CoreLogic. About 22.3% of homeowners with a mortgage owed more than their homes were worth at the end of June, down from 23.7% three months earlier.

From 2007 to 2011, the slide in home values cut real estate wealth by $6.7 trillion, an amount equal to about 43% of the overall economy, UBS Securities LLC economists led by Maury Harris wrote in an Aug. 24 research note. Wealth may have increased $600 billion in the first half of 2012, they wrote, noting the boost to spending may come sooner than Meyer’s forecast.

The reversal will provide “meaningful support” to growth, lifting consumer spending by as much as 0.5 percentage point at an annual rate, according to the UBS economists.

EXPANSION SUPPORT
That could help the world’s largest economy expand by 2.1% this year and 2.3% in 2013, they wrote.

“Homes are for most people the largest asset that they hold, so if there’s a recovery not only would there be an improvement in net worth, but there would also be a potentially even more important psychological impact,” Drew Matus, senior economist at UBS, said in a telephone interview from Stamford, Conn.

In Fannie Mae’s August National Housing Survey, 35% of respondents said they believed that home prices would rise in the next 12 months, compared with 20% a year earlier. Eighteen percent of those surveyed said it was a good time to sell, compared with 9 percent a year earlier.

“Rising home prices also lead people to consider investing more in homes,” Matus said. “Very few people actually get in early in a rally, so price increases could potentially be more encouraging for people to join.”

Borrowing against one’s home, nonetheless, is harder for many people in the wake of the recession, damping some of the wealth effect, Meyer said. Only one of the 58 senior loan officers surveyed by the Fed said standards for home equity lines of credit, one way housing wealth can stoke spending, were easier in July than they were in 2005. Forty said they were tighter.

“The credit channel is an important part of the story as well,” Meyer said. “That probably made the wealth effect more powerful during the boom, but I would argue that it’s going to make the wealth affect more muted now.”