America's Wealth Effect From Rising Home Prices Has Been Cut in Half

A legacy of the real estate bust.
Photographer: David Paul Morris/Bloomberg

The U.S. consumer might be the engine of global growth — just not the roaring V12 it used to be.

From the fourth quarter of 2003 through 2006, amid the real estate bubble, personal consumption expenditures grew at an average annual clip of 3.5 percent. Since the S&P/Case-Shiller Composite 20-City Home Price Index bottomed out in March 2012, however, personal consumption expenditures have increased by just 2.3 percent, on average.

In an economic letter published by the Federal Reserve Bank of Dallas, economists John Duca, Anthony Murphy, and Elizabeth Organ identify one reason why this American muscle car has lost its nitrous oxide.

The researchers found that the wealth effect from real estate — that is, the extent to which home price appreciation juices consumer spending — has been cut in half since the mid-2000s:

Housing Wealth Effect
Source: Dallas Fed

The chart shows that around the middle of 2005, households would spend an extra $3.40 in the event that their home gained in value by $100. Near the end of 2015, households would increase outlays by just $1.70 if real estate values rose by the same amount.

"In other words, home prices in 2015 need to rise double as fast as in 2005 in order to generate the same impact on consumer spending," writes Torsten Slok, chief international economist at Deutsche Bank AG. "This weaker wealth effect is a key reason why the recovery since 2009 has been so weak."

This finding reinforces the challenge that monetary policymakers faced in reflating the U.S. economy via large-scale asset purchases, as this transmission channel didn't pack the same punch it used to.

The wealth effect for liquid assets, such as bank deposits, is substantially higher than for illiquid assets like real estate, a testament to the ease with which the former can be deployed.

The housing bubble of the aughts was characterized not only by soaring real estate values, but also households' penchant for using real estate as a piggy bank to finance current consumption.

In the wake of the crisis, access to credit by this channel was curtailed dramatically and the debt overhang served as a notable drag on consumption, to boot.

"In the U.S., increased availability of consumer and mortgage credit, along with rising asset prices, contributed greatly to the consumption boom in the mid-2000s; reversals in these factors exacerbated the bust in consumption during the Great Recession," the authors wrote.

Years removed from the bust, households may still be scarred from its effects and reticent to tap into home equity lines of credit.

However, even without a supercharged boost from rising home prices, the authors conclude that the outlook for American consumer spending remains bright, buoyed by the improvement in household balance sheets, renewed access to credit, and a stock market near all-time highs.

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