The improving housing market is beginning to serve as a tailwind for the economy after years of dragging on growth. The Commerce Department reported on Tuesday that new-home sales were up by 29% from one year ago in January, and the S&P/Case-Shiller index that tracks home cities in 20 metro areas showed that prices were up by 6.8% from one year ago in December.
But one of the housing sector's most effective multiplier effects on the economy—the so-called "wealth effect" in which people spend more because they feel richer as the value of their home (or stock portfolio) increases—could be muted for the next few years, according to economists at investment bank Credit Suisse CSGN.VX -3.74%.
Housing contributes to the economy in two main ways. The most direct contribution comes from home construction and improvement. But it also drives consumer spending through housing's wealth effect, which is seen most directly when borrowers tap into their home equity to fund everything from vacation and college tuition to home renovations and dinners out.
Credit Suisse economists Neal Soss and Henry Mo found that wealth effects have shrunk since the 2007-08 financial crisis, and the housing wealth effect appears to be less potent right now than the stock market wealth effect.
See inventory and listing prices in major markets.
Why? Messrs. Soss and Mo provide three compelling explanations.
First, housing wealth has been much more volatile since home prices went down in 2006. Prices ticked up in 2009 and early 2010 amid several rounds of home-buyer tax credits, only to slide until hitting bottom one year ago. If households are less likely to view gains in home prices as permanent, "their willingness to spend will thus be restrained," they said in a recent report. In other words, more volatile wealth isn't as valuable as more stable wealth.
Second, today's gains in home prices are following a period in which home prices declined by 30% on a national basis (and by even more in bubble markets across California, Arizona, Nevada and Florida). Home price gains "that simply restore previous declines would have a smaller effect on consumption than consistent gains like those before house prices began the first sustained slide in living memory in early 2006," the report said.
Finally, tight credit standards have made it harder to take cash out of homes through either home-equity lines of credit or a cash-out refinance, where a homeowner refinances into a larger mortgage and takes out cash. So even if more homeowners have equity, it may not matter if lenders don't allow them to withdraw it.
The Credit Suisse economists conclude that the potential stimulus from housing-wealth-related consumption could be substantial in the medium-term, but that it is unlikely to provide enough of a boost this year to offset the lower disposable income associated with recent increases in the payroll tax.
http://blogs.wsj.com/developments/2013/02/26/housings-wealth-effect-isnt-what-it-used-to-be/
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