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Home equity loans hike spending: Greenspan

Home equity loans hike spending: Greenspan
Loans taken against value of home may have lifted U.S. spending by almost 3 percent.
April 23 2007: 3:27 PM EDT

WASHINGTON (Reuters) -- U.S. spending may have been lifted by close to 3 percent a year in recent years as owners tapped the enhanced values of their homes for cash, according to a paper coauthored by former Federal Reserve Chairman Alan Greenspan.

The findings could have big implications as the country's housing market cools, affecting such homebuilders as Pulte (down $0.48 to $27.92, Charts, Fortune 500), Centex (down $0.79 to $45.81, Charts, Fortune 500) and D.R. Horton (down $0.78 to $22.61, Charts, Fortune 500) as well as banks such as Bank of America (down $0.48 to $50.56, Charts, Fortune 500) and Wachovia (Charts, Fortune 500). Some economists say the Fed should cut interest rates because the housing downturn will brake consumer spending and tip the economy into recession.
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Greenspan, who departed the helm of the U.S. central bank on Jan. 31, 2006, wrote the paper with Fed economist James Kennedy to study how the booming practice of home equity extraction - raising cash by borrowing against surging house prices - might affect the U.S. economy.

The market value of U.S. owner-occupied homes has more than doubled in value to $18 trillion in the last decade, and the paper sees a multibillion-dollar benefit to U.S. spending.

"From 1991 to 2000, equity extraction financed an average of 0.6 percent of total PCE [personal consumption expenditure], but since then that share has risen to almost 1-3/4 percent," they noted in the paper, released by the Fed on Monday.

This climbs even more if the net is widened to capture the indirect impact on spending of home equity finance used to pay down nonmortgage debt like credit card bills - on the basis that these were really bridge finance for spending anyway.

"If we include nonmortgage debt repayments, equity extraction financed an annual average of about $115 billion of PCE from 1991 to 2005.

"By this broader measure of PCE funding, equity extraction financed 1.1 percent of PCE from 1991 to 2000 and close to 3 percent from 2001 to 2005," Greenspan and Kennedy said.

Judging the past importance of rising housing wealth for consumption provides clues for guessing how hard it will hit spending now that the boot is on the other foot - a topic that the paper did not address head-on.

U.S. housing has cooled since 2005, with declining home prices and mounting problems in the subprime mortgage market for borrowers with tainted credit raising fears that this could spill over into the rest of the economy and lead to a recession.

Greenspan himself said last month that there was a one-third risk of a recession this year.

So far, the U.S. economy has suffered only a moderate slowdown confined mainly to the construction and auto sector and parts of manufacturing directly linked to housing.

Consumers have continued to spend, and Fed officials expect this to remain the case thanks to positive income growth and tight labor markets reflected by low unemployment, which fell to 4.4 percent in March from 4.5 percent the month before.

However, private sector economists are more skeptical and will scrutinize details of first-quarter gross domestic product, due to be released by the government on Friday, for evidence that the slowdown has spread.

Some analysts forecast growth for the quarter could dip below a 2.0 percent annual rate, compared with 2.5 percent in the previous three months. Top of page