Households Will Not Retrench in 2006

Spending by households on consumer goods and services, as well as on homes, has been the backbone of the U.S. economy throughout the economic expansion that began four years ago. Indeed, personal consumption expenditures (PCE) and residential fixed investment (RFI) have combined to account for nearly nine-tenths of overall GDP growth during this expansion period.

NAHB’s forecast shows a modest slowdown in GDP growth from 2005 to 2006, with some slowing of both PCE and RFI. But a loud chorus of analysts is contending that a overextended consumer poses a huge risk to the economic outlook for 2006. This chorus is focusing on a negative personal saving rate, record household debt burdens, and heavy reliance on inflated real estate values to support consumer spending.

It’s true that impressive growth of household net worth has permitted negative saving rates as well as accumulation of record debt burdens, and recent data from the Federal Reserve show that household balance sheet foundations are now stronger than ever. But those analysts who fear a serious retrenchment of household spending in 2006 worry about two things: first, rising interest rates that could slow the turnover of the housing stock and discourage borrowing against equity by homeowners; second, an interest-rate related contraction of house values that could seriously erode the equity base, pulling the rug from under debt-financed personal outlays.

These are legitimate concerns in a rising interest rate environment. However, realization of the type of interest rate outlook in the current Blue Chip consensus forecast, or in NAHB’s forecast, will not seriously damage house values or cause a major cutback in consumer spending. Indeed, Fed Chairman Greenspan has pointed out that housing equity is now so large that most households could easily absorb a moderate setback (if it occurs). Furthermore, housing equity will continue to support consumer spending even if higher interest rates cut into housing turnover, home equity loans and cash-out refinancings. Believe it or not, housing equity does not actually have to be “extracted” (to coin a Greenspan term) with debt in order to support household spending. Credible research shows that the accrual of capital gains is a lot more important than the “realization” of gains through borrowing, and the accrual has already occurred.

Comments

[William P. Kearney]

As for the NAHB economic report, I agree that consumers have refinanced too-much, however as for the fed raising rates that effects short term rates! mortagues are long term & track the 10yr Treasury Note. Since April. 1st & 2nd are Pension, Profit-Sharing, 401-k 403-b Plan Company Match dead lines for 2005 contributions, these monies typically hit the market & are invested within 30 days historically quicker. Usually we see pensions invest heavily in the 10yr note, hence more buyers result in a rise in price & yield decrease. That is since there is an inverse relationship between price & yield a lower yield will result in lower mortague rates. However this will be short lived. Interesting fact the stock market in general does well April 1st thru mid April each year! ~ Bill ~

[Tony Jackson]

Are "exotic loans" a worry to your organization? I understand that several billion dollars worth of loans will be converted in 2006, increasing exponentially for the next several years. Some may be able to refinance, but not all. And many of those will default or be forced to sell.

What will this do to housing appreciation and the market?