Life After Housing's ATM

In 2003, during the thick of the housing bubble, a New York Times article discussed the virtues of cashing out home equity. One couple cashed out $40,000 for their daughter's wedding. Another "used $20,000 in equity to fly to Nepal for 10 days to celebrate their 30th anniversary." Another lucky beneficiary of the boom cashed out "$2.5 million -- $1 million to pay debts and the remainder for reasons he was reluctant to discuss."

Yes, this is old news beaten to death by the media. Early in his presidency, President Barack Obama snapped at an advisor for giving a presentation on how homeowners cashed out during the boom. "Guys, this is great research," he said, according to a staffer. "But you're telling me that people have been using their houses as ATMs. I could have told you that."

Far less appreciated, I think, is where mortgage equity withdrawal is now, and how it's affecting today's economy.

At the peak of the housing bubble in 2005, homeowners were cashing out $275 billion of equity per quarter, which amounted to nearly 10% of disposable income. This was, quite literally, as if the nation got a collective 10% raise that could be spent on jet skis, kitchen remodels, or vacation homes.

Today it's the exact opposite. Mortgage equity withdrawal has been negative for several years. That happens when homeowners pay off more of their mortgage than their scheduled payments require. In the first quarter of this year, net equity extraction was -$107 billion, or the equivalent of 3.6% of disposable income. The finance blog Calculated Risk tells the story:


The impact this has is enormous. In 2005, homeowners had $800 billion to spend in addition to what they earned, just from the amount pulled out of their homes. That was the equivalent of more than double Wal-Mart's (NYS: WMT) global revenue. With MEW now running negative, Americans will have about $400 billion less to spend on consumer expenditures this year than they would if they weren't rushing to pay down their mortgages.

Now, MEW wasn't a net gain back then, and it isn't a net loss today. MEW during the housing boom meant more debt. Negative extraction today means less. Ultimately, the latter is exactly what we need to do to get back on a healthy track. But when 70% of the economy is driven by consumer spending, and when your spending is my income, the impact this stuff has on growth adds up fast. It explains most of why the economy is slow these days.

Here's what's really interesting. Calculated Risk has another chart showing what GDP growth would have been without MEW during the housing boom. It shows that the economy would have been in or near recession for most of what we considered the "boom years" had consumers not been using their homes as ATMs:


This makes me wonder: What would economic growth be like today if MEW wasn't negative? Using the same methodology as this chart, I estimate GDP growth in the first quarter of this year would have been around 3.5%, rather than the 1.9% that was reported. And as a rough rule of thumb, every 1% of GDP growth translates into about 1 million jobs. You can do the math.

Over the long haul, economic growth is all about entrepreneurs, new ideas, population growth, and productivity. The reason our economy is stagnant today is not because those key drivers are crumbling -- productivity and population growth are fairly strong. It's stagnant because what should have been a slow economy last decade frontloaded a boom by robbing growth from today through debt. Growth should be decent today, but it's not, because we're paying for last decade's frontloaded boom by paying off that debt. This is simple stuff, but sometimes the simple stuff is what matters most.

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Fool contributor Morgan Housel owns shares of Wal-Mart. Follow him on Twitter @TMFHousel. Motley Fool newsletter services have recommended creating a bull call spread position in Wal-Mart Stores. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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