At Calculated Risk, the question of relationship between mortgage equity withdrawals and consumption is one of the central ones. Indeed, when MEW is at 5% of disposable personal income, it seems that this number is very crucial part of real consumption.

Those who argue that housing collapse does not affects consumption usually say that people are smart enough to not use MEW to directly fund consumption, so decline in MEW should not affect that component of GDP.

I agree that while people usually do not use MEW to purchase plasma TV’s, but that’s where the money flow will end up anyway. Let see. Suppose people use MEW only for legitimate reasons:

  • Remodel the house, purchase second home, make a down payment for bigger home, service debt on the home. In that case money go builders, agents and brokers – and they will count it as income and purchase plasma TV
  • Purchase better health insurance, send kids to college. In that case money go to hospitals and colleges, they count them as income and purchase plasma TV
  • Restructure past financial mistakes. In that case plasma TV was already purchased, but later financed with MEW
  • Tap MEW to cover unexpected problems, like loss of job and so one. In that case the bankruptcy is avoided, so the bank lenders are not experiencing the losses, profits are intact, share prices are rising – and that makes bankers and investors to purchase plasma TV

In 2005 and 2006 the rate of personal defaults and bankruptcies was at historic lows, because whatever happens, eventually the MEW could be used to make the book. As shown above, whatever reason for MEW, it will end up as another plasma TV

Advertisements