Wikinvest Wire

An extra trillion dollars a year

Monday, April 23, 2007

Today's report on mortgage equity withdrawal from the team of former Federal Reserve Chairman Alan Greenspan and Fed economist James Kennedy make the words of Warren Buffet even more meaningful today than they were a few years ago.

The Oracle of Omaha once said something like, "Give me a trillion dollars and I'll show you a good time too!" and though he wasn't referring to home equity withdrawal at the time, the sentiment surely applies.

Bloomberg reports that between 2001 and 2005, Americans have been "tapping their equity" to the tune of a cool $1 trillion a year "took out an average of $1 trillion in cash from home equity".

Today's paper is a follow-up to research by Greenspan and Kennedy in 2005 that showed that extraction of home equity accounted for about four-fifths of the increase in mortgage debt. That paper was Greenspan's first since 1996.

Including repayment of non-mortgage debt, such as credit card loans, the cash financed 2.9 percent of consumer spending from 2001-05 compared with 1.1 percent from 1991-2000, the authors said.

Since Greenspan, 81, retired from the Fed in January 2006, he has been giving paid talks to investor and industry groups and writing a book, ``The Age of Turbulence,'' set for release in September.

In February and March, Greenspan roiled financial markets with predictions of a possible U.S. recession this year, placing a ``one-third probability'' of such an occurrence.

With today's research paper on the phenomenon of ``equity extraction,'' though, the former Fed chief is trying to steer clear of any controversy. Some critics say Greenspan held interest rates too low for too long after the 2001 recession, helping inflate home-price bubbles around the country that are now popping and threatening to torpedo the economic expansion.
Too low for too long?


There are a couple of charts in the report that is supposed to be available at the Federal Reserve's website but it looks like you'll have to search around to find it. This link(.pdf) will get you a copy from what appears to be a public area of the Wall Street Journal Online.

The first chart shows how quickly home prices have risen in the last few years and, more importantly, the ominous flattening of the "housing wealth curve" in 2006. Remember, the trick here is to keep real estate prices going up faster than real estate debt - once that dynamic reverses, then, well ... that's what's happening now.

Amid the sharp increases in total real estate value in recent years, people own a smaller and smaller share of their homes - surprise!
There's a bit more data in this report that may make for a few more interesting charts, specifically, how all that extracted money has been spent - stay tuned.


Anonymous said...

Surely some mistake...If the US has a $13 trillion economy, and the consumer accounts for, what, 40%, then total consumer spending would be around $5 trillion. And one trillion a year would be 20%, not 2%. But that can't be right, can it?

Tim said...

I've been looking at the report and am in the process of making up a chart or two (it's pretty interesting).

The $1 trillion refers to what they call "free cash" as a result of a home sale, equity loan, or cash-out refi.

A large portion of this gets used to buy another house or is invested or saved. Only about a tenth of that amount shows up in GDP as PCE (personal consumption expenditures), the balance is used for non-mortgage debt repayment (paying off previous PCE) and home improvements.

Anonymous said...

Blame the cash-out craze on the consumer, or maybe unethical mortgage brokers- not Greenspan. Did Greenspan make borrowers pull out cash to blow on vacations and corvettes???

Anonymous said...

Vern: No, but he certainly encouraged it. C'mon, you can't reasonably expect people to not take on debt after you lower interest rates to clearance levels!

Anonymous said...

I will tell you what I bought with my cash out: a new stamped concrete driveway, marble counter tops, kick ass landscaping, a trip to Vegas, and a brand new Navigator! Guess what, my payment is lower now then before I got that stuff, who’s laughing now. If things go bad and home prices drop, I will just walk away with everyone else, but I will still have my Navigator!

Anonymous said...

How about updating the chart you already have - the SoCal Median Price Chart?

The best on the net!

Thanks Tim!

Anonymous said...

obviously, lower interest rates spur lower equity holdings. The question is how much have we deviated.

Tim said...

The SoCal housing charts get updated around the middle of the month - the last update was about ten days ago here.

Anonymous said...

Our Navigator-driving poster is funny: Even if s/he stays above water in terms of new mortgage payments, just imagine the added cost of paying a few thousands dollars worth of marble, concrete, or air miles of at ~6% for 15 - 30, assuming some modicum of common sense was used. And this to say nothing of the new debt s/he will accumulate along the way.

Anonymous said...

There should be another chart, that shows income.

Since income is flat, and debt is increasing, foreclosure must be increasing.

Anonymous said...

Tim, I am sorry I missed that, and THANK YOU for taking the time to update those!

Anonymous said...

Greenspan cost George Bush Sr. his last presidency because he would not lower interest rates and thus read my lips.
His son became the beneficiary of the "you owe me pay back". The Feds were the sole reason we have $250,000 homes in California selling for $500,000, because they allowed lenders to loan money and float paper into the secondary market for anyone who could fog a mirror. This is not a joke and while you may walk away with a navigator your economy has been permanently damaged. Creative financing is simply a nice way of saying we will loan to anyone and those that have actual stability will pay the price in increased housing costs for those that will compete to drive up the price and in the end drive away in there Navigators?

Anonymous said...

Regarding the quote "give me a trillion dollars and I'll show you a good time too" - did that come from Warren Buffett or was it Jim Rogers?

Tim said...

It was Buffett:

‘Give me a trillion dollars and I'll show you a good time, too,’ was Buffett's answer. He was replying to a different question, addressing the beginning of today's boom, rather than its end. The source of the present excitement on Wall Street, Buffett implied, was neither a real economic recovery nor a genuine bull market. Instead, it was a response to more than a trillion dollars' worth of stimulus. The federal budget went from surplus to deficit - a swing of more than $700 billion - in an 18-month period. Cutting interest rates rapidly, the feds also managed to light up the housing market - adding hundreds of billions to the economy through mortgage refinancings and new construction.


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