A Historic Change

"A year into the housing market's slowdown, Americans have yet to snap shut their wallets, defying predictions that the cooling market would have a chilling effect on consumer spending," writes Christopher Conkley in The Wall Street Journal. The theory has run as follows: One of the main reasons American consumers have been able to continue spending at such a liberal pace is that they have been able to pull money (equity) out of their personal residences with low-interest-rate home equity loans. Now that interest rates have risen a bit, it is both less attractive and (often) less possible to pull the needed money out, so consumers should soon have less disposable cash to spend. Or so the theory goes. Consumer purchases, though, have increased this year at a 3% pace, which has been the rate of growth for the prior two years as well. One is justified in asking the obvious question: Why? Making the matter even more confusing is the fact that the number of new home equity loans being taken out has declined a bit, as one would have expected. But not the amount of money we're spending. Where, then, is the money coming from?

Tell Me Why...Economists are split on this one. What they agree on, of course, is that it's confusing.

"Even though consumers appear to betapping home equity less than they have in the past, they are still finding ways to sustain their spending." And here's a conundrum even Alan Greenspan would appreciate: "Sales at building-material and garden-supply centers are up more than 8% from a year earlier, outpacing the 6.7% year-to-date jump in overall retail sales, according to the Commerce Department. Sales at furniture and home-furnishing outlets are up 6.5% from last year." One possible group of reasons that this is so may be lumped together as "offsetting factors," or reasons to be cheery about the economy in spite of the fading home equity loan game. People are less worried about losing their jobs; unemployment is low; corporate profits are up, as is capital spending (at last); and this proves to be a crucial matter the price of a gallon of gasoline has fallen very noticebly at the pump.

Life, in other words, is looking a lot better and saner to most consumers. So perhaps they feel more willing to spend than they otherwise would. Another possible reason we are all still willing to open our wallets and spend is that the reality of a slowing housing market hasn't quite sunk in yet. You will recall the often-discussed "wealth effect" that seemed to make us all more willing to spend when our homes had gained a great deal of value. It may be that the wealth effect is still alive since housing really hasn't lost much value and indeed, is still somewhat strong in some areas. Homeowners, unlike Wall Street analysts, aren't inclined to believe that their personal residences will lose much of their value. But what about a possible "reverse wealth effect"? What if home values continue to correct in some areas? What if the cost of getting at our equity continues to rise (because interest rates continue to rise)? What if we wake up one morning and realize we have less disposable income than we thought we did, and we all start to cut back on our purchases? Well, what if, indeed. None of this seems all that likely at least not at this point.

Increasingly, your Wrapman is less worried about the American consumer than most of the gloomy forecasters who see retail purchases slowing to a trickle. Most of the debt that we're talking about is held by higher income borrowers who can weather the relatively small storms of future home price corrections. Even the vast field of dominoes we've been told will fall the homeowners who took out adjustable rate mortgages when rates were far lower and who may have to scramble to keep up with debt service when their loan payments adjust higher. I have a great deal of faith in the likelihood that there simply will be no cascading toppling of dominoes. People who have to will indeed scramble to make higher payments. Others will refinance into fixed-rate loans they can handle, if they haven't already. Others will be helped by savvy mortgage lenders, by secondary market programs and by local assistance.

There will be a bit of pain in other words, but it isn't going to bring down the national economy. In fact, it will probably prove to be a very small blip on the larger radar screen. So...does that mean there's nothing to worry about? Far from it.

There's this other borrower see, and things are only now starting to get genuinely tense. His name is Uncle Sam.

Article provided by Fidelity National Title Company.

Source: Wednesday Wrap, October 2006.