Thursday, August 21, 2003

America’s seemingly indefatigable consumer played a crucial role during the latest recession and the jobless recovery that followed. The relatively mild recession would have been much more severe (and probably longer) had the consumer not remained so tireless throughout the downturn. Also, the weak recovery would have been without the continued strength of personal consumption, which accounted for more than 70 percent of gross domestic product (GDP) last quarter.

Probably no factor contributed more to the economy’s indispensably robust consumption during the recession and recovery than the increasingly liquefied home-mortgage market. Over the past three years, mortgage refinancings and home sales have repeatedly delivered hundreds and hundreds of billions of dollars to households through equity extractions during the mortgage-refinancing process and the realization of sizable capital gains from home sales. The recent big spike in long-term interest rates may signal that the refinancing binges and soaring home values have come to an end. If so, the predictable effects may reduce consumption. This would occur at the very moment when policy-makers, politicians and workers are hoping for an acceleration of the economy’s growth rate in order to begin to reverse the loss of 3.25 million nonfarm private jobs since the eight-month recession began in March 2001.

According to Freddie Mac, the monthly average interest rate for a 30-year fixed-rate mortgage bottomed out at 5.23 percent this past June, nearly 2 percentage points below the June 2001 rate. The monthly average rate for a 30-year mortgage reached its cyclical peak in May 2000 at 8.52 percent. Last week, the rate was 6.24 percent.

As for refinancing, Federal Reserve Chairman Alan Greenspan said in a March 4 speech that nearly 10 million regular home mortgages were refinanced in 2002. He estimated the dollar volume of these regular refinancings to be $1.75 trillion, net of cash-outs. In addition to the cash-outs from refinancing and home-equity loans, households extracted another $350 billion in home equity last year through the capital gains realized on the sale of 6.4 million existing homes. Altogether, Mr. Greenspan estimated that households extracted about $700 billion in previously built-up equity from owner-occupied housing in 2002 alone.

Much of the extracted home-equity funds have financed consumption, which has been increasing much faster than GDP since the beginning of 2001. The question is: If the mortgage-refinancing boom and the rise in home values have simultaneously petered out, how will consumption increase at a sufficient rate in order for the annual growth rate of GDP to accelerate beyond the 4 percent that is necessary to achieve a sustainable increase in employment? Understandably, that now is a concern of policy-makers.

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