Steep slide for MEW

From Bloomberg:

Housing Bust Meets the Equity-Withdrawal Blues: Gene Sperling

While the subprime and exotic mortgage fallout has been grabbing recent housing headlines, another potential story for 2007 may be in the wings: as Americans withdraw less equity from their homes will it mean a big or little hit for growth and consumer spending?

The connection between housing and consumption isn’t a new story. Economists have long assumed that there is a so-called wealth effect from rising home prices: for each dollar of housing wealth accumulated, people spend anywhere from 4 cents (as conventional economic models predict) to 9 cents, as John Hopkins economist Christopher Carroll found in a December study.

Yet, the dramatic expansion of mortgage-equity withdrawal, or MEW, by homeowners over the last decade has raised new and less-settled issues over whether housing wealth now has a greater impact on consumption that ever before. Many — me included — have likened home-equity withdrawals to automated-teller machines, with owners literally taking money out of their houses to bolster consumption.

Goldman Sachs Group Inc. has found that consumers spend about 50 cents for each dollar of home-equity extraction and cash-out refinancing. The International Monetary Fund, using a different methodology, has found that 18 cents are spent per dollar of home-equity withdrawal.

Nonetheless, there is no unanimity on the causal connection between mortgage-equity withdrawal and spending assumed by the ATM theory. The Congressional Budget Office, for example, surveyed the equity-withdrawal research in a recent study and said the evidence regarding the size of the effect on spending was “inconclusive.”
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Consider that between November 2001 and August 2006, inflation-adjusted wages didn’t gain a penny. As of 2005, real median family income was $500 below its 2001 level. All the while, consumption averaged a respectable 3.2 percent between 2002 and 2006. While the negative personal-savings rate provides some explanation, the vast rise in equity withdrawal amid escalating home prices does seem to help complete the puzzle.

The explosion of mortgage-equity withdrawal over the recent housing cycle was given greater prominence by the Federal Reserve, thanks to work by former Fed Chairman Alan Greenspan and Fed economist Jim Kennedy. In December 2005, Greenspan and Kennedy published a new, comprehensive measure of equity withdrawal that went beyond the information provided in the Fed’s Flow of Funds data.
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Their research showed an amazing development. Between 1995 and the final quarter of 2005, equity withdrawal grew to 8 percent of the economy from 1 percent — a whopping 800 percent increase. And as of the fourth quarter of 2005, when total MEW had reached its peak, it stood at $1 trillion annualized.
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But it is too early to bury falling MEW as a consequential economic event. Those who worry about the impact of mortgage- equity withdrawal caution that there might be a lag of as long as six months between declines in MEW levels and changes in consumption.

Only time will tell. But don’t yet count out the potential of declining mortgage-equity withdrawal to join subprime mortgages as one of the more depressing housing stories for 2007.