Read it here first: Real-Estate Boom Soon May Sputter As an Engine of Retail Sales

A key part of my Bearish thesis for 2006 has been that as interest rates tick up, the Real Estate cylinder in the economic engine will fade.

Yesterday’s WSJ had a good article on that exact subject:

"As home sales start to slow and the inventory of unsold homes rises, some economists are warning that home-price appreciation will slow or prices will possibly even decline next year. And that, they say, will lead to a slowdown in consumer spending that could start as soon as the holiday season ends.

Leading the worrywarts are economists at Goldman Sachs Group Inc. For several years, they have been closely watching what the firm dubs MEW, which stands for mortgage-equity withdrawal. It is the cash people extract from their homes by drawing on home-equity loans, "cash out" mortgage refinancing, or capital-gains earnings from real-estate sales…

Jan Hatzius, a Goldman Sachs economist, estimates Americans will withdraw $834 billion from residential real estate this year. That will fall next year, he says, to $758 billion and to $645 billion in 2007. "As households’ cash flow goes down," Mr. Hatzius says, "spending weakens." That, in turn, will reduce economic growth.

Equity withdrawal isn’t the only way that housing is supporting the economy. According to Moody’s, the real-estate industry is responsible for creating 1.1 million of the two million net jobs that the nation added in the five years that ended in October. Those jobs include positions for land surveyors, general contractors, loan officers and building-material retail workers."

Note that the ugly part of the accompanying chart (via  Goldman Sachs) are projections, and not actual declines:

MEW= Moprtgage Equity Withdrawals


A few other data points on this:

A study (supposedly co-authored by Fed Chair Alan Greenspan) estimated that "Americans withdrew $600 billion in equity from their homes in 2004, or 7% of their disposable income." Greenie’s study estimated "consumers spend about 51% of the cash they extract." Goldman’s estimates were that consumers spend ~68% of the cash they extract through home-equity loans and refinancing (most of the rest is used to pay down credit-card debt or invest).

WSJ:  "In other words, Goldman believes that consumer spending is even more closely tied to home equity than does the Fed. If Goldman is correct, that means the housing slowdown will have a bigger negative impact on spending and the economy than commonly thought."

See also Unsold house inventory highest since April 1986



Real-Estate Boom Soon May Sputter As an Engine of Retail Sales
Rafael Gerena-Morales
The Wall Street Journal, November 28, 2005; Page A2

Unsold house inventory highest since April 1986
Newsday, November 29, 2005,0,5463507.story

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  1. -cman- commented on Nov 29

    What’s your take on possible effects of home heating costs this winter exacerbating the cooling (heh!) housing market? I read James Kunstler mostly for entertainment, not for clear-eyed prognostication. However, he does make a pretty compelling argument this week.

    The price of natural gas is back to where it was just after Katrina-and-Rita : about $11.50, which is roughly 400 percent higher than it was as recently as 2002. The longstanding assumption that home heating comes cheap will go down hard in this country. The homebuilding industry is going to get crushed. They will be stuck with tens of thousands of already-built spec houses in the larger-than-3000 square foot range, with great rooms, lawyer foyers, and other heat-sucking features, and they will have tens of thousands more of them under construction or tagging close behind in the permitting process. Practically all of them will be located in the remotest suburban asteroid belts, since the closer-in ones have already been built on.

    Add to this predicament the number of people already living in houses like this who may be desperately looking to get out of an increasingly ominous trap, perhaps compounded by additional problems with “creative” mortgages that have left them leveraged above their eyeballs. Some of them will be looking at heating bills as high as their monthly mortgage payments around Christmas time. If enough of them panic this winter, the housing bubble, which is already deflating, will simply fly to tatters and shreds.

  2. Riley Murphy commented on Nov 29

    This is an interesting read. I mentioned this possibility to my wife a couple weeks ago. I undertand that the majority of new jobs (here in san diego anyway) are a result of the real estate industry. Past research for housing price declines have a high correlation with job losses…Perhaps the fact that people:

    1) aren’t taking $$ out of their house to do upgrades due to slowing appreciation.
    2) aren’t able to sell their houses.

    will have an effect on a broad spectrum of the industry that depends on these 2 activities (loan officers, real estate agents, home depot, general contractors, etc., etc. etc.) which could result in these folks not being able to make payments on their own homes – or feed discretionary income back into the economy, which could negatively effect other sectors….which could create a negative feedback cycle regarding housing prices. It will definitely be interesting to see what happens. Has anyone reading this actually invested in the “hedge” fund that is tied to declines in housing prices? I’d be interested to hear your views on this…

  3. cluster_fluck commented on Nov 29

    There was also an article in WSJ about a real estate “professional” going on a $43,000 shopping spree in New York with his family. When I read that, it just makes me want to cry. I’ve been scraping to save $100k and this guy is going on $43k shopping sprees.

  4. Fritz commented on Nov 29

    Is there data out there discussing the over picture of this situation coupled with soon to be seen fuel based inflation ( Although it’s hardly scientific most of the resturants near me have increased their prices twice in the last 7 months.)

    Furthermore what effects will rising interest rates have on the interest only ARMS or their evil cousin the partial interest only ARMS that simply require part of the interest to be paid while the remaining interest is added to principal?

    The way I see it, people are borrowing without thought to buy their “Starter Beemer”, and plasma TV, while companies are cutting benefits and retirement controbutions and medical costs are soaring and pensions (for the lucky few who have them) are going bankrupt.

    Of course I guess I should be written off as a sky is falling type.

  5. B commented on Nov 29

    The housing and consumer spending debate is surely a hot topic and an emotional debate. I’ve read everything from negative savings rates to the American public has $55 trillion in savings. $35+ trillion sans home equity. It points out that there are statistics, da*n statistics and lies. (Just like our friends at the NRF) And one needs to determine which side of the fence the author is on and the objective of the author to actually interpret the data. There is no doubt in my mind the consumer is not tapped out. Simply looking at MZM or other similar measures of money supply clearly shows there is ALOT of savings in short term instruments. To say that China has $2 trillion in savings and Americans with 40x the standard of living has a net negative savings rate is preposterous. Similalry, anyone who buys healthcare, a house, gas or food knows inflation is not 2%. But, a little inflation is better than deflation in a world where the latter is the bigger serious threat.

    In addition, home equity is not just used as an ATM as the extremely bearish would have you believe. A vast majority of home equity is used as future investment just as equity on the books of corporate America is used. Americans aren’t foolish, albiet they may be mathematically challenged. New additions, new kitchens, college funds, etc make up the majority of equity withdrawal. A new big screen TV? Well, sure, why not.

    Bearish Malthusian economists and “experts” would have you believe the world is coming to an end. But wages are increasing and employment is robust. And, lest they forget about the Fed. While Uncle Sammy may want to maintain price stability, they are also Americans and patriots who will use whatever means possible to ensure our future stability, employment and prosperity. If long rates have hit a peak, and it appears they may have, short rates may likely drop at the exact time da bears are saying short rates will kill the consumer. Whether that is a statement of today or six months from now, it is likely a truism.

  6. David Silb commented on Nov 29

    (Insert Big Sigh Here) Just to throw a little gas on the fire, did you all see the 60 minutes report on the expanding square footage boom in the nation?

    My question is how many are ARM’s, How many are corporate bonuses, and how many are just “I deserve it?”

    My take is that after the longest economic expansion that ended after 9/11, is people still think the good times are still rolling. If the associated data presented by our beloved blogger is true someone’s gonna get hurt.

  7. D. commented on Nov 29


    We have friends in the landscaping business who have been making money like water in the last few years. They built themselves a house for 350K in 2001 and not even 1 yr later got an offer for 750K from an American who was working for Merck (Many of the people living in that area’s McMansions work for Merck)

    They refused the offer holding out for 1M$.

    The Canadian dollar is up 50% since then, Merck is laying off and Americans are not bidding as often anymore.

    Easy come, easy go. When money is made too easily, many people tend to think they are god’s gift to the world or simply that good times will be there forever.

    In the LONG RUN, both the disciplined and the intrepid get what they deserve most of the time.

  8. David Silb commented on Nov 29

    To Fritz,

    I bet you are from the Neo-Classical School of economic thought. Something about post stuck with me.

    So I thought about it and it hit me.

    Here’s what it reminded me of; “Everybody sing along!” “…Gee our old Lasalle ran Great.”

    (Copy and paste this into your browser.)

    (The above is ment in the spirit of jest and not to ridicule, so please take in the fun it is ment to be.)


  9. Fritz commented on Nov 29


    Perhaps my problem is my desire to assume others operate rationally. I know the sky isn’t going fall, nor are the pillars of the economy going to crash. I just look around a see an economic party that refuses to end and wonder what the hangover will feel like and how many bystandards will be harmed.

    Take that recently graduated lawyer who owes $200,000 in student loans together with his wife, lives in a modest $200,000 home, drive used cars with balances of $10,000 each and together they bring home $120,000 tops. What are they to do except hope inflation drives down the value of their loans and forces an increase of income? Surely they’re not going to have kids b/c their insurance only kicks in after $2000 is paid. Keep in mind these are the well off newlyweds.

  10. Idaho_Spud commented on Nov 29

    Recessions are a normal part of the economic cycle. That a recession could be triggered by the collapse of this *irrational* housing bubble and the ‘asset economy’ where you borrow against your stuff (as though your stuff can only go up in value) does not seem at all unlikely.

    I’m not a perma bear, but there is enough imbalance in the system to make me very cautious right now.

    People have apparently forgotten that you cannot spend your way to greater wealth. Read Warren Buffet in case there is any uncertainty about this :)

    There are certainly a lot of systemic challenges that need to be negotiated very carefully at this point. “Fanron”, for one. Marginal borrowers getting squeezed by their ARMS and non-core inflation (ie non-discretionary spending), plus a huge amount of liquidity that is even starting to show up in the core rate (which excludes anything that goes up in price).

    Q2 06 next recession will likely be ‘official’. For 30K GM workers its here right now.

  11. Larry Nusbaum, Scottsdale commented on Nov 29

    Idaho_Spud –
    1. If I sell my home, when do I get back in?
    Imagine the awful disappointment of anyone who sold their home, on the advice of another, six months ago, twelve months ago or two years ago? This was NEVER good advice and, as a result, they may never get back in. At least, not cheaper.
    2. I recently attended a Mutual Fund & Retirement seminar. There were about 100 attendees. Most were senior in age. The host asked a simple question: “How many of you plan to sell your home in order to cash out the equity and move to a rental while investing the proceeds?”
    TWO HANDS OUT OF 100 WENT UP. How does the bubble burst if everyone stays in their house? It’s not like massive supply is coming to market at once, (like stocks in 2000/2001)
    3. Only 18% of the loans have a loan-to-value ratios above 90%, making forclosure risk minimal.
    4. Anyone who thinks that rates moving another 100bp even from here are high, have no memory for what “high rates” really are……

  12. D. commented on Nov 30


    1. You don’t need higher rates, all you need is a recession. There are many people who need two incomes to pay for their mortgage right now.

    2. You don’t need everyone defaulting on their mortgage to have prices come down. All you need are a few cash-strapped owners to sell out.

    ex: You make 100K per year. You bought your house in 2001 for 275-300K. New buyers buy in the area at 500K. Valuations go up and taxes go from 3000$ to 6000$ per year. You have a variable rate mortgage of 200K. You started off at 3.5-4% now it’s going up 1 or 2%. That means at least 2000$ more per year. Your gas is costing you 500$ more and your heating another 500$.

    Since 2001, your annual cash outlay has increased by 500$ per month. You were 45, now you’re approaching 50 and you realize your budget is tight, not enough money to retire and that 500$ per month is cutting into your savings. You could sell at 350K and still make a nice little profit, making the latest buyers extreme suckers.

    3. Not all real estate is in a bubble. In our area, starter homes have doubled and McMansions have doubled since 2001. Everything in between is mostly up 50%. Most people don’t have the cash to renovate and buy. Banks tend to lend for what your house is worth, not what it could be worth after the renos so it’s much easier to get a jumbo loan for the new house. Now that real estate has boomed, banks are making it easier to fund renovations but still, most people need money and patience and most people want everything NOW, so they buy new.

    The effect of this:
    2500 square foot house from the 70-80s: 85-100$ per square foot.
    2500 square foot house new house: 140-200$ per square foot. (where laminate counters = 140$ per square foot, Granite counters = 200$ per square foot!!!)

    Even if houses do not drop, I am willing to bet that in 10 years, there will be a much smaller discrepancy between the old and new house price per square foot. Buyers in 2015 will not want to pay a premium for 2001 kitchens because they won’t be new anymore.

    Obviously, most owners are going to be ok and others will reel.

    4. 85% of debt taken on in the last few years has been taken on by boomers. I guess they are expecting the younger generation to fund their retirement by buying up their expensive houses. They better be patient because for the first time since the 30s, the group that will be there to buy (Gen-X) is smaller than the group that will be retiring/selling in 4-5 yrs.

    5. As soon as house prices stop increasing, the soundness of a 30K-50K kitchen reno will be debated. And then the economy will suffer.

    6. It takes owners about 6 months to spend the cash-out. So we still have another 6 months of healthy consumer spending.

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