April 23, 2007 / 6:36 PM / in 12 years

Spending boosted by home equity loans: Greenspan

WASHINGTON (Reuters) - U.S. spending may have been lifted by close to 3 percent a year in recent years as owners tapped the enhanced values of their homes for cash, according to a paper coauthored by former Federal Reserve Chairman Alan Greenspan.

Former Chairman of the Federal Reserve Alan Greenspan speaks the Conference on U.S. Capital Market Competitiveness in Washington, in this March 13, 2007 file photo. U.S. spending may have been lifted by close to 3 percent a year in recent years as owners tapped the enhanced values of their homes for cash, according to a paper coauthored by Greenspan. REUTERS/Jim Young

The findings could have big implications as the country’s housing market cools. Some economists say the Fed should cut interest rates because the housing downturn will brake consumer spending and tip the economy into recession.

Greenspan, who departed the helm of the U.S. central bank on January 31, 2006, wrote the paper with Fed economist James Kennedy to study how the booming practice of home equity extraction — raising cash by borrowing against surging house prices — might effect the U.S. economy.

The market value of U.S. owner-occupied homes has more than doubled in value to $18 trillion in the last decade and the paper sees a multibillion dollar benefit to U.S. spending.

“From 1991 to 2000, equity extraction financed an average of 0.6 percent of total PCE (personal consumption expenditure), but since then that share has risen to almost 1-3/4 percent,” they noted in the paper, released by the Fed on Monday.

This climbs even more if the net is widened to capture the indirect impact on spending of home equity finance used to pay down nonmortgage debt like credit card bills — on the basis that these were really bridge finance for spending anyway.

“If we include nonmortgage debt repayments, equity extraction financed an annual average of about $115 billion of PCE from 1991 to 2005.

“By this broader measure of PCE funding, equity extraction financed 1.1 percent of PCE from 1991 to 2000 and close to 3 percent from 2001 to 2005,” Greenspan and Kennedy said.

Judging the past importance of rising housing wealth for consumption provides clues for guessing how hard it will hit spending now that the boot is on the other foot — a topic that the paper did not address head-on.

U.S. housing has cooled since 2005, with declining home prices and mounting problems in the subprime mortgage market for borrowers with tainted credit raising fears that this could spill over into the rest of the economy and lead to a recession.

Greenspan himself said last month that there was a one third risk of a recession this year.

So far, the U.S. economy has suffered only a moderate slowdown confined mainly to the construction and auto sector and parts of manufacturing directly linked to housing.

Consumers have continued to spend, and Fed officials expect this to remain the case thanks to positive income growth and tight labor markets reflected by low unemployment, which fell to 4.4 percent in March from 4.5 percent the month before.

However, private-sector economists are more sceptical and will scrutinize details of first-quarter gross domestic product, due to be released by the government on Friday, for evidence that the slowdown has spread.

Some analysts forecast growth for the quarter could dip below a 2.0 percent annual rate, compared with 2.5 percent in the previous three months.

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