 |
 |
 |
 |
 |
 |
 |
 |
Shopping Centers Today -> July 2001
 PRINT THIS STORY: |
  CHANGE TEXT SIZE: |
HOME PRICES HELP 'WEALTH EFFECT'
Rising housing values may offset the impact of stock market swings on consumer spending
By Michael Baker
 |
 |
 |
Although a weak manufacturing sector and collapsing business investment have been held primarily responsible for the faltering economy, retail sales have also been increasingly soft. Among the few retail categories to continue reporting strong same-store and total sales growth throughout the first quarter of 2001 were drug and discount stores — i.e., retailers selling basic consumables and prescription drugs. Meanwhile, retailers of more economy-sensitive items such as jewelry have seen sales dip.
Analysts have expended a lot of ink (or keystrokes) wondering whether the "wealth effect" spawned by years of stock market gains was turning tail and working flat out in reverse now that the market was on the retreat. However, it’s important not to lose sight of the fact that stocks are just one kind of asset that can drive a wealth effect.
Discussions about the wealth effect (the marginal propensity to consume out of an additional dollar of wealth) usually focus on stock market wealth. Yet stock market wealth still represents only about one-third of the net worth of U.S. households, approximately the same as tangible assets (real estate and consumer durables). Moreover, stock ownership is highly concentrated — less than 50% of households own stocks and about 50% of the value of all stock holdings resides with the top 1% of stock owners. (James M. Poterba, "Stock Market Wealth and Consumption," Journal of Economic Perspectives, Spring 2000) Therefore, one would expect large stock-market-driven wealth effects to be restricted to a relatively small number of households. It’s also worth remembering that a significant amount of stock market wealth is held in retirement saving accounts such as 401Ks and IRAs, and some consumers are less inclined to raise or lower consumption in response to changes in the value of retirement assets.
This is not to say that the overall impact on consumer spending is negligible — even if one dollar of stock market gains (losses) generates as little as a penny additional (less) consumption, as some research suggests, the dollar difference to total consumer spending is meaningful. Therefore, a large stock market decline would certainly put some dent in consumer spending.
However, in the current circumstances, any fall in the stock market will wholly or partly be offset by a rise in home values. (See Figure 1.) Housing wealth is much more widely distributed across the population, and home prices have risen significantly as Figure 1 shows. Consumers are taking advantage of this, along with falling interest rates, to refinance their mortgages and take cash out of home equity. (See Figure 2.) According to the Washington, D.C.-based Mortgage Bankers Association, mortgage interest rates peaked in the second quarter of 2000 and have since declined by 140 basis points, to 6.9% in the first quarter of 2001. The response of home owners has been to increase refinancings from $41 billion to $174 billion over the same period, or from 21% of the total value of mortgages to 50%.
There are several benefits from refinancing — a home owner can lower monthly mortgage payments, or shorten the loan term, or take out equity to consolidate higher-interest-rate debts and/or spend.
How much of this refinancing activity has been "cash-out" refinancing — i.e., refinancing in which the home owner cashes out equity? The overwhelming majority of it, according to data from Freddie Mac. In the last five quarters for which data are available (the fourth quarter of 1999 through the fourth quarter of 2000), cash-out refinancings have accounted for roughly four out of every five refinancings. (See Figure 3.)
According to data for 1998-99 compiled by the Federal Reserve, consumers are using funds from cash-out refinancings for home improvement (33%), debt repayment (28%), investment (21%) and "spending" (18%) (Brian Nottage, "Decaying Household Finances," www.dismal.com, April 16, 2001).
Thus, we see a positive wealth effect in action, offsetting the potential negative impact of a decline in the stock market. This may help to explain why consumer spending — though much weaker than a year ago — has been as resilient as it has.
Michael Baker is assistant director of research for ICSC.
 | Current Issue November 2008 |