Say Goodbye To Refi Madness

Homes aren't the cash cows they were. That could crimp consumer spending

Falling interest rates and rising home prices have been good to Alfredo Andre. The 40-year-old warehouse supervisor tapped the rising value of his two-family Cranford (N.J.) home twice in the past four years, using the $70,000 in cash proceeds from a home equity loan and a subsequent refinancing to buy a minivan, remodel a first-floor apartment, and pay off credit-card debt taken on by his family of five. Yet he kept his monthly mortgage payment to about where it was before he took on the extra debt. "It has worked out perfectly," he says.

It worked out pretty well for the rest of the U.S., too. Even as businesses struggled and the ranks of the unemployed swelled, Americans turned their homes into cash machines, taking out hundreds of billions of dollars in the past three years that helped sustain consumer spending. "It has been instrumental in keeping the economy afloat," says Mark M. Zandi, an economist with the consulting firm Inc.

But as rates rise sharply and home price increases ratchet down, the flow of cash from housing equity is sure to slow in the coming year. And except for a blip from tax refunds in the first half of 2004, fiscal stimulus will diminish. The reduction in cash from housing wealth could reduce gross domestic product growth by 1.5 percentage points from what it would have been otherwise. That risks turning what would have been a gangbuster expansion into a more modest one. And it will make job and income growth crucial to sustaining robust consumer spending.


Clearly, the end of the refi boom is here. Drawing on data from the Mortgage Bankers Assn. and Freddie Mac Corp., BusinessWeek estimates that the number of applications for cash-out refis has fallen about 50% since the refi peak at the end of May. At the same time, housing prices are rising more slowly, so there's less new wealth for homeowners to extract. The Office of Federal Housing Enterprise Oversight home price index rose at an annual rate of just 3.1% in the second quarter -- down from 8.8% a year earlier and the smallest increase since 1996.

That will put a crimp in consumer spending. Throughout the tepid recovery, consumers have shown an amazing ability to raise their spending despite weakness in the job market: Inflation-adjusted average hourly earnings have risen only 3% in the past three years. Making up the shortfall and then some, homeowners have spent cash that they raised via home equity loans, cash-out mortgage refinancing, or sales of properties in which they didn't reinvest all the proceeds in another house.

The impact of that spending has been enormous. Goldman, Sachs & Co. estimates that households will end up extracting an astounding $600 billion from their homes in 2003 and spending perhaps half. All told, the increase in cash from housing is likely to account for about 20% of the rise in consumer spending this year. With the hit from rising rates just beginning to be felt, Goldman calculates that the amount of cash that consumers will squeeze from their housing equity will fall by half in 2004, to some $300 billion.

Some of the pain is already being felt, especially by retailers. And it will get worse: A recent survey from market researcher NPD Group Inc. found that the average consumer plans to spend $637 this holiday season, down 4% from last year. The decline in cashing out is also a setback for the banking and mortgage lending sector, which has been one of the few bright spots in the labor market. Together banking and mortgage lending has added 150,000 jobs since January, 2001, while the overall economy has lost 2.6 million, according to the Bureau of Labor Statistics. Now there may be a pullback. Mortgage giant Countrywide Financial Corp., for example, has let go 1,700 of its 36,000 employees since July. More cuts in the industry are expected.

Can the expansion absorb such a blow? Yes, but the impact will be significant. Goldman Senior Economist Jan Hatzius expects economic growth of 4% in the fourth quarter. Merrill Lynch & Co. North American economist David Rosenberg is even more pessimistic: He says he has used a range of assumptions in his GDP forecasting model -- but "no matter how hard we try, we can't get fourth-quarter growth over 3%."

Fortunately, there are countervailing forces building in the economy to pick up some of the slack. The rise in the stock market will help, as the wealth effect could encourage consumers to spend. Strong job growth, though, would do the most to minimize the impact. But a lukewarm jobs recovery won't do the trick. In September, for instance, the economy added just 67,000 jobs -- the first such growth in eight months. Goldman's Hatzius pegs 100,000 jobs a month as the rough amount needed to offset the downturn in cash from the mortgage market. Credit Suisse First Boston economist Jay D. Feldman puts the number at about 2 million jobs a year, which comes to more than 150,000 jobs a month.

It's too early to know how strongly job growth will kick in. But don't count on much of a lift from other past key sources of stimulus, including fiscal policy. Yes, tax refunds will be higher than usual in 2004 because of this year's tax cut. But overall federal budget deficits, which stimulate demand and thus boost GDP, will be a smaller factor. The deficit is expected to grow about $125 billion in the fiscal year that began Oct. 1, far less than the nearly $220 billion rise for the year that ended Sept. 30.

When the economy gains speed and interest rates rise, as they have, it's only natural that homeowners cut back on turning their housing wealth into cash. But the economy has become so hooked on the kick from refinancings that weaning it away is sure to be tough.

By Christopher Palmeri in Los Angeles and Peter Coy in New York, with Rich Miller in Washington

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