A recent report by Charles Schwab & Co. detailed the tight connection between the Housing Market Index and the S&P 500, as illustrated by the following chart.
Five years ago, the Federal Reserve was determined to keep the popping of the internet bubble, the economic recession, and the aftermath of 9/11 from turning into a self-reinforcing collapse.
Short-term interest rates were lowered to 1%, banks encouraged mortgage holders to refinance and withdraw equity, lending standards were lowered, and a rash of new adjustable mortgage (ARM) products were introduced.
All served to fuel speculation in residential housing, thereby boosting prices to an unprecedented level, which in turn reinforced more specualation.
The increase in real estate prices spurred increases in personal net worth, which in turn fuled a consumption boom and sustained economic growth.
And, with demand came more supply.
The report further noted:
- 32.6% of new mortgages and home equity loans in 2005 were interest-only; up from 0.6% in 2000.
- 43% of first-time borrowers (25% of ALL buyers) in 2005 purchased with no down payment.
- 15.2% of 2005 buyers owe at least 10% more than their home is worth.
- 10% of all homeowners with mortgages have no equity in their homes.
- $2.7 TRILLION in loans will adjust to higher rates in 2006 and 2007.
One of the last remaining vestiges of the real estate boom has been sustained mortgage equity withdrawals (HELOC’s), providing ready cash that has continued to spur consumer spending.
To many economists’ surprise, mortgage equity withdrawals have remained high, thereby sustaining consumer spending. The ultimate danger, however, is that these equity withdrawals will eventually end and thereby cause a collapse in consumer spending.
The report goes on to say that the housing industry is more important to the overall economy than many are currently assuming.
The harder housing falls, the harder it will be for the economy to land softly.
Sobering stuff indeed.