The Hidden Driver of the Housing Bubble: Mortgage Equity Withdrawal

The housing bubble's impact on the US economy can be attributed to the significant increase in mortgage equity withdrawal, which allowed homeowners to borrow against their rising home equity. According to a recent academic paper by Atif Mian and Amir Sufi, homeowners extracted an average of 25 to 30 cents for every dollar increase in home equity, with most of the funds being used for consumption rather than investing in new real estate or paying off high-interest debt. This phenomenon played a crucial role in the economy's growth from 2002 to 2006, accounting for nearly 2.3% of GDP each year.

Key Takeaways:

• The sharp rise in US household leverage from 2002 to 2006 and the increase in defaults from 2006 to 2008 can be attributed to homeowners borrowing against the increase in home equity.
• Homeowners extracted an average of 25 to 30 cents for every dollar increase in home equity, with most funds being used for consumption.
• Home equity-based borrowing was stronger for younger households, households with low credit scores, and households with high initial credit card utilization rates.
• Homeowners in high house price appreciation areas experienced a relative decline in default rates from 2002 to 2006 but a significant increase in default rates from 2006 to 2008.
• The 2.3% of GDP each year accounted for nearly all the economic growth from 2002 to 2006, with most economists modeling the wealth effect of rising home values at less than $0.10 on the dollar.
• The data corresponds to the lack of increase in median income over the period and explains why people who bought their houses near the top are in trouble right now.
• Historically, Residential Investment (RI) has been the primary driver of the economy's recovery out of a recession, but it may be hard to see RI lifting the economy this time due to the large number of foreclosures and available housing inventory.
• The absence of a V-shaped recovery implies a broad-bottomed U-shaped recovery, with RI having already shrunk to its smallest percentage of GDP on record.
• Zombie banks could turn the recovery into an L-shaped recovery, also known as 'turning Japanese.'
• The policy responses to prevent the current economy from turning into an absolute disaster will come with a cost down the road, implying either higher taxes or lower government services.

Statistics:

• Homeowners extracted an average of 25 to 20 cents for every dollar increase in home equity.
• 2.3% of GDP each year was accounted for by home equity-based borrowing from 2002 to 2006.
• Real GDP growth averaged 2.68% from 2002 to 2006.
• The median income did not increase over the period.
• Residential Investment (RI) has shrunk to its smallest percentage of GDP on record.
• The Federal Reserve's balance sheet has expanded substantially, raising the risk of out-of-control inflation as the economy recovers.

Sources:

• "Mortgage Equity Withdrawal: The Financial Implications of House Price Growth" by Atif Mian and Amir Sufi
• Zacks Investment Research
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