Home Prices and Consumer Spending Fallout

By William A. Strauss
NABE Board Member
Senior Economist and Economic Advisor
Federal Reserve Bank of Chicago

Housing prices, which historically have rarely experienced nominal price declines, are falling at a significant rate.  The three members of the home price panel uniformly agreed that of the several different housing price series available, the Case-Schiller series seems to be the “best” series to use.  The three panelists were: David Berson, The PMI Group, Inc.; Richard Peach, Federal Reserve Bank of New York; and Mark Zandi, Moody’s Economy.com.  Roy Webb, Federal Reserve Bank of Richmond, moderated the session.

They also agreed that while home prices using this series have already declined by nearly 10 percent from the peak, home prices still are likely to fall an additional 10 to 15 percent, leaving prices 20 to 25 percent below their peak value. The panel expects it will take at least another year, or perhaps three, before the bottom is reached on home prices.

There are still too many new homes on the market and record high existing homes for sale.  While the excess supply of homes is quite large, it is understated because cancelled contracted homes are not put back on the list of unsold homes, and with cancellation rates quite high, this is not a trivial issue.
The old expression that the three most important factors about real estate are location, location, location applies to today’s housing market.  Regionally there are huge differences in home price movements.  Most of the significant declines in prices have been occurring in areas that experienced significant gains over the past several years, in large part driven by investors.  These areas include many cities in California, Florida, Arizona, Nevada, New York, Massachusetts, and the District of Columbia.  Weak prices are also occurring in Ohio and Michigan, but in large part this is more a factor of weak economic conditions and not excessive price appreciation.

One presenter worried that lower interest rates by the Fed are not translating into lower mortgage rates and hence will not help the housing sector very much; and another pointed out that tighter lending standards by banks will challenge the housing turnaround.

How Much Will Housing Weakness Cool Spending?

A second panel discussion focused on the possibility that weakness in housing may result in sustained softness in consumer spending. Speakers were:  Peter Hooper, Deutsche Bank Securities; Charles Steindel, Federal Reserve Bank of New York; and Chris Varvares, Macroeconomic Advisers. Paul Bennett, NYSE Euronext, was the moderator.

The panel members suggested that wealth effects from falling home prices pose a major downside risk to consumer spending, but impacts may be less severe than conventional estimates would suggest.  In large part, the impact will be determined by how consumers perceive the change in home values.  If they believe it to be permanent, it will have a stronger effect on spending; but if the decline is viewed as transitory, it should have relatively little effect on spending.  In addition to falling home values, equity market declines are also reducing wealth.

The panel suggested that the range of declines in consumer spending due to the reduction in wealth could be from a low of 1.5 percent to as high as 7.5 percent.  If consumers look past the housing bubble, much as they did with the stock market bubble of the late 1990s, the declines in the lower range would be more likely; but even these declines are quite substantial when you consider that the consumer makes up more than two-thirds of gross domestic product.