Yesterday Calculated Risk pointed out the flaw in a lame attempt to disassociate house inflation from the rampant consumption that went bust last year. The survey purported to show that house price inflation didn’t have all that much effect on spending; no, no it’s not all that.
There are two parts here: 1) how do changes in house prices effect consumption, and 2) how does access to the Home ATM effect consumption. On the second point, I think the answer is MEW had a significant impact on consumption … I frequently heard from auto, RV, boat, motorcycle, and home accessory retailers that their customers were borrowing from their homes during the boom to buy these products. All of these areas have seen sharp declines in consumption as MEW had declined.
This severe decline in consumption was easy to predict - and it happened. Meanwhile these authors dismiss it as simply “a theoretical possibility”.
The point of the exercise? To foster enough economic happy talk that you, the consumer, let down your guard and start buying again - for the good of the order and all that. This latest study was brought to you by the most academicky of academics, so it must be true!
Which brings us, again, of Mickey Kaus’s cogent observation in September 2007.
…Why do I pay attention to anecdotal evidence? Because academics are always the last to find out what’s happening. If you wait until a social trend turns up in some professor’s peer-reviewed charts,** you are waiting too long. (Example: Anecdotal evidence always said people spent a long time on welfare. Academics said they didn’t. Until, after a decade or two, the academics looked at their printouts more carefully.)
Ten years from now the economists will tell us what really happened. Maybe. For now, believe your eyes and ears: If someone is spending way beyond his means, and you can’t figure out where the money is coming from, they’re probably like this guy.
on Jun 24th, 2009 at 10:47 am
“Some observers point to the latest housing boom, and the increased use of HELOCS and other mortgages during the boom, as evidence that housing prices spurred consumption through this financing channel. While this indirect financing channel is a theoretical possibility, it is an empirical question whether it is significant in its effect, and even if the indirect financial effect is present it should not produce a “first-order” effect of housing wealth on consumption; housing wealth should still matter much less for consumption than other forms of wealth.”
That is a lame argument. The “theoretical possibility” that housing wealth (unrealized capital gains) created a new “financing channel” for consumption is a fact. And it is also a fact that it exploded. When that financing channel disintegrated, a vast amount of consumer spending went with it.
One would have to be an idiot to await empirical data to confirm what happened. The evidence is scattered all over our economic landscape, and when taken in sum, it is easy to see the process:
1. Government fiscal policy encourages subprime mortgage lending, while government monetary policy greases the skids. The two combine to set off a housing boom.
2. Government fiscal policy discourages credit card borrowing (no tax deduction for interest charges), while encouraging borrowing against home equity (tax deduction for interest charges).
3. Consumers run up credit card balances to unsustainable levels, and then liquidate those balances by borrowing against their houses. (Automobile loans, student loans, and so forth are also being paid with money from home equity loans.)
4. Housing boom ends when supply outstrips demand; house prices collapse, creating negative equity in homes (upside down mortgages) and trigger mortgage defaults, which in turn trigger foreclosure sales and further price declines; loans against home equity (the new “financing channel” for consumption) disappear, which in turn triggers defaults in credit card loans, auto loans, student loans, etc.
5. Demand collapses for the goods and services previously purchased with money borrowed against home equity; recession results.
Note: I also think the argument that “both consumption and housing prices were driven by changes in expected future income” is suspect. It is true that some people will increase their consumption or prices in the belief that future income will be higher, but most people only do that when the income is actually in hand, which, in this case, is the difference between an unrealized capital gain and a realized capital gain.
For example, some people might go out and borrow money for a new car in the belief that their stock market portfolio will only increase in value, but most people will sell their stock and then buy the new car.
In any event, when “expected future income” looks like it will be less than current or past income, it is not hard to imagine the direction for consumption and housing prices.