The next big thing for economy is thought to rely heavily on real estate. Exactly what that will bring is yet to be determined, but that doesn’t stop speculation, including the question on everyone’s mind: How will the correction now underway in housing affect consumer purchasing? A little, a lot, or something in between?
Everyone has a theory, but as of yet no one has a definitive answer. That’s the nature of the future: it’s unknown until it arrives. Nonetheless, the question about real estate is a loaded query, based on the fact that the collective spending habits of Joe Sixpack and company represent 70% of GDP. Add to that the recognition that housing tends to represent the biggest item on the balance sheet for any given consumer. As a result, boom and bust, bull and bear are largely determined by Joe and friends, which can be influenced by real estate.
Because the recent past has been marked by spending–inordinately so in the eyes of some–it’s been easy to assume that more of the same is coming. Exactly how much real estate corrects, and exactly how much that influences consumer spending remains the great unknown. But it’s clear that a connection exists between the two, and perhaps more than a casual observer realizes, suggests a new report from the IMF, which will be included in the next installment of the group’s World Economic Outlook, scheduled for release next week.
Thanks to new technologies and deregulation, it’s become easier to borrow against the value of homes in the U.S. to finance consumption, the IMF advises. Consumers have availed themselves of the opportunity, but it’s come at a price: higher debt. The trend isn’t limited to America. Households in nations with relatively flexible and open economies on par with the U.S.–so-called arm length economies–have witnessed a similar trend in borrowing and debt.
“Well developed arm’s length financial systems, such as those in the United Kingdom and the United States, enable households to borrow against the rising value of their homes, thereby boosting consumption and supporting strong economic growth,” the IMF counsels. This,

however, results in households having higher debt—an average of 160 percent of disposable income in 2005 in arm’s length systems compared to less than a 100 percent in more relationship-based systems. Households in arm’s length financial systems are therefore more vulnerable to rising interest rates and a downturn in asset prices. So, for example, during previous housing busts in countries with more arm’s length financial systems, consumption growth typically slowed from an average of 3 percent (year-on-year) at the start of the bust to zero two years later. The slowing of the U.S. housing market is a key risk for the U.S. and global economic outlook.

The fear that U.S. households have taken on a relatively large amount of debt, courtesy of the housing boom of past years, is supported by the trend in the Federal Reserve’s financial obligations ratio (FOR) for homeowners, a gauge looks only at payments on mortgage debt, homeowners’ insurance and property taxes relative to disposable personal income. By this measure, homeowners’ debt level in the first quarter of 2006 reached its highest in more than a quarter century, as the chart below illustrates.
The bull market in household mortgage debt doesn’t insure that consumer spending is set to slow, but neither does it inspire confidence that Joe can maintain the torrid pace of purchasing he’s set in the past. In fact, judging by Wednesday’s release of the Fed’s Beige Book report,a survey of economic conditions across the nation, both optimists and pessimists can find support for their outlook.
“Consumer spending increased slowly in most [Federal Reserve] Districts, weighed down by sluggish sales of vehicles and housing-related goods,” the Beige Book reported. “Consumer spending increased modestly in most Districts since the last report, though a few Districts reported flat to declining sales. In general, sales of autos and home-improvement and other home-related goods tended to be weaker than for other categories.”
Overall, a variety of strength and weakness was observed in the Beige Book, leaving investors room to rationalize any forecast they want about where the economy’s headed. But today’s guesses will give way to fresh data. As the search for clarity intensifies, so too will the focus on each new data point. Next Thursday’s update on August retail sales and business inventories, as a result, promises to draw more than average attention. It’s but one more data point, but any number’s as good as the next as an excuse to review, reassess and re-examine.