Housing's Wealth Effect - I'm Skeptical

There is no question that home prices are pulling back. This pullback is most pronounced in parts of the country that say the most rapid price appreciation, such as Florida and California. Many other parts of the "heartland" did not experience the same degree of price run-up and not see the same amount of depreciation.

There have been lots of stories in the media about how the run-up in housing prices, facilitated by record low interest rates, has fueled a wealth effect. In other words, people felt more wealthy due to the appreciation in their houses. There has also been a lot of commentary about homeowners using the increased equity as an "ATM", funding spending and lifestyle changes. Now that home prices are headed down, the worry is that consumers will spend less - pushing the U.S. into recession.

I am skeptical of the the whole wealth effect argument and the effect to which the majority has been using their house as a "piggy bank". This skepticism is purely anecdotal and based on my own musings. I have friends that made a lot of money flipping beach property during the bubble. I also have friends that made money but also got caught holding Florida real estate they cannot afford to sell.

But for the average family that was not speculating in an overheating market, I don't see the ATM argument - that surplus home equity was the driver of the consumer economy. Yes, if you bought a house in an inflated market in the last 18 months, it is possible to be upside down. But the majority of homeowners have held their homes longer, or sold a home at an inflated price and bought another at a similarly inflated price, the angst is just not there.

I just don't buy the fact that people are spending more or less based on home values being up or down. Plus, if you've had your home for a while it is likely that you have an equity line of credit that can be drawn on anyway - no cash-out refinancing required. More than half of all homeowners own their homes outright.

Yes, you can refinance and take cash out of your house. But homes are mostly illiquid. Jobs and rising income and stock market gains have a much greater impact in people feeling wealthy - and therefore the money they spend. In other words, if people have a decent job with rising wages, they are going to spend that money regardless of the value of their home.

It is the American way.