Last years the boom of real state prices helped raising household wealth, pushing consumption spending with it. Rising housing prices and lower interest rates have increased the borrowing capacity of households. The increase in borrowing (collaterized against houses) has surpassed the net new spending on housing assets. This is the so-called housing equity withdrawal. People have drawn part of the equity in their housing stock and used those funds for other purposes (consumption). When housing prices start falling, equity withdrawal cannot continue and consumption is negatively affected.

This week we saw some of this in the US economy. The picture below from Greenwich Capital summarizes it. Data on mortgage equity withdrawal was announced last week pointing out that as of the 4th qtr last year, gross home equity withdrawals dropped to $115.8bn. This is a reasonable fall if we consider that it peaked at $1.05 trillion in the 3rd quarter of 2005. If we measure it as percentage of disposable income, equity withdrawal has dipped from 11.4% to 1.18%. This has had the expected effect on consumption, as spending data released that week has shown. For the US, retail sales (ex-auto/gasoline) have fallen from 9.1% to 3.6%. This is rough evidence on how the housing price cycle is affecting consumption and might affect the general level of the economy. Visual statistics can be done overlaying the Fed Funds rates in the picture and guessing that the Federal Reserve could take measures soon to avoid any further fall. The market has already priced in a drop of 29 basis point in the Fed Fund rates by September. Still inflation is ticking higher (as shown in data released last week as well) which creates uncertainties about the future path of monetary policy in the US. Dealing with the real state slump is not going to be an easy job.



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