So this morning I stumbled across a little tidbit from a report published by the Canadian Association of Accredited Mortgage Professionals (CAAMP). I haven’t been able to get it out of my head. The report itself contains a wealth of interesting data, but there was one sentence that just tripped me up:
“The survey data indicates that 18% of mortgage holders took out equity from their homes or increased the amount of the mortgage principal within the past twelve months. The average amount of equity take-out is estimated at $46,000.“
The report then goes on to calculate that the total equity withdrawal is in the ball park of $46 billion. The report outlines a number of things that the money was used for: renovation, debt consolidation, investing, miscellaneous consumption, etc.
I can’t believe that people can gloss over that number!
Let me reiterate some basic math: If 18% of all households with mortgages (~60% of total) have withdrawn equity in the past 12 months, and the average amount was $46K, that means that when averaged across all households, it would be equal to over $5,400 in additional household spending per household in the past 12 months. Given that the median after tax income of Canadian households was most recently calculated at $63,900, this equity extraction has ‘boosted’ income and spending by an additional 8.5%.
While equity extraction in the US peaked at a higher rate than we are currently experiencing, it is worth noting how that worked out for them. Today, equity extraction in the US is negative, meaning people are actually paying that debt off. More than anything else, this has hampered the US’s ability to get out of the nasty recession/anemic growth they are in. People don’t want to spend. Too much consumption has been pulled forward. People have too much debt.
Where that money goes is irrelevant. It would not be money in circulation had people not borrowed it. More to the point, consider that this has the sole effect of pulling demand forward and creating an artificially strong level of consumer spending. The reality is that when house prices normalize (read: fall), not only will equity withdrawals cease very rapidly, they will actually go negative, as seen in the US.
The Dallas Fed published a paper (authored by none other than Alan Greenspan) in which they examined the wealth effect and Mortgage Equity Withdrawal (MEW) as a root cause of the difficulty the Fed faced in trying to resuscitate the economy:
“One estimates (of the impact of rising home prices on consumer spending) that a $100 rise in housing wealth leads to a $9 increase in spending. Another finds that increases in housing wealth generate three times the spending from stock-price gains.
Together, higher home values and financial innovations have enabled homeowners to more easily tap housing wealth. Mortgage equity withdrawals have risen sharply recently relative to income.
By this measure (home equity withdrawals) have become more sensitive to swings in home-price appreciation, aided by the lower cost and greater ease of cashout mortgage refinancings”
In other words, this whole equity withdrawal business is driven primarily by rising home prices, which are now at extreme valuation levels all over the country. This practice has the effect of borrowing from tomorrow’s consumption. What would have been bought tomorrow has instead been bought today on cheap credit. As a result, when this unsustainable withdrawal of equity ceases, it will have the effect of not only choking off consumer spending, but also of eating into the consumer spending that would naturally have existed as people will then be paying off the debt they accumulated on their spending binge.
None of this bodes well for our economy…none of it. This is a structural issue with how the Canadian economy has generated growth since at least 2005. To correct this will involve a recession, likely by Q3 2011, or as soon as people realize that their homes aren’t worth what they thought they were, home equity withdrawals dry up, and consumer spending abruptly dives.
When that happens, you just remember where you read it first!