Why rising house prices could be great for American consumers | Waccabuc Realtor

A lot of the speculation about what an improving housing market will mean for the economy has centered on new construction. After all, if the housing sector comes roaring back, new homes being built will translate into more construction workers with jobs.

But there’s another way that the improvement in housing could translate into economic gains, one that is potentially larger but much harder to estimate in advance. One of the biggest questions for the economy in 2013 is how much a stronger housing market will translate into more consumer spending. It matters a great deal; residential investment is 2.5 percent of overall economic activity right now, while personal consumption is 71 percent. It would be great to see a rise in building activity, but the consumer is where the major macroeconomic action is.

House sold? Time to go to the mall. (SOURCE: REUTERS)

A good starting point is “wealth effects.” This is simply the idea that when people become wealthier, such as when their stock portfolio rising in value, they will feel more flush and therefore spend more money. Figuring out just how large these wealth effects might be is notoriously difficult, and they can vary a lot depending on any number of factors. A 2006 study estimated that a $1 rise in the value of homes triggers 2 cents of additional spending in the quarter immediately following, and nine cents total. In a paper last year, Charles Calomiris, Stanley Longhofer, and William Miles found that the wealth effects from housing vary significantly depending on whether the homeowner is old or young, poor or rich—but their overall estimate is that a dollar of extra housing wealth triggers five to eight cents in additional spending.

That, by the way, is much more than their two cent estimate of the wealth effect from a gain in securities. In other words, if Calomiris and his colleagues’ estimates are right, rising home prices should mean more for the American consumer than a comparable rise in the stock market.

So what would that mean in practical terms for growth? Over the year ended in November, the Federal Housing Finance Agency’s index of U.S. home prices rose 5.6 percent. If that rate of home price increases continues, it would increase the value of the entire U.S. housing stock, $17.2 trillion in the third quarter, by about $963 billion.

Using the Calomiris estimates, an increase in home values on that scale should then trigger between $48 billion and $77 billion in extra spending. On the high end of that estimate, that would represent about an 0.7 percent gain in consumption spending and half a percent gain in GDP. That may not sound like a lot, but is a pretty big deal; in an economy that has been growing at a 2 percent rate for the last three years, 2.5 percent would be a welcome shift upward.

But there is reason to suspect that this unique economic moment could make the impact of higher home values higher than usual. In the Great Recession, spending fell by even more than could be attributed solely to the wealth effects caused by falling home prices. A vicious cycle set in through which falling home prices contributed to people being underwater on their mortgages, which had an outsized impact on their spending. Research by Atif Mian, Kamalesh Rao, and Amir Sufi last year found that in counties with high degrees of household debt and home price declines, retail sales fell much more than elsewhere.

That raises some interesting possibilities. It seems at least plausible that this vicious cycle could work in reverse. If homeowners who ended up underwater on their homes accounted for a disproportionate drop in spending, could home price increases that bring their net worth into positive territory have a disproportionate positive effect on spending?

We are in sufficiently uncharted territory that it is hard to predict with confidence, but this may be one of the best hopes for an improved consumer-driven economy in 2013. Maybe, just maybe, there exist tipping points by which a rise in home prices pushes families from owing more than their home is worth to owing less, and once they cross that tipping point, they will spend more freely.

Regardless of whether that effect exists or not, what is clear is that at a time when spending will come under pressure from a rise in the payroll tax, the best hope for the American consumer is to be found on the home front.