Will a Cooling Housing Market Cool the Economy?

The housing market has shown signs of cooling in recent months. Economists wonder how that might affect the overall economy in the United States. Steve Inskeep talks to David Wessel, deputy Washington bureau chief of The Wall Street Journal, about the relationship between home equity and consumer spending.

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STEVE INSKEEP, host:

Here's another sign that the housing market may be softening. The commerce department announced this morning that sales of new homes fell five percent in January. That's bigger than expected. It's also the second time in three months that sales have dropped, with higher interest rates making it harder for people to afford to buy a house. The question now is whether that will affect the broader economy. And we're going to explore that with David Wessel, whose is deputy Washington bureau chief for the Wall Street Journal, and a regular guest here. David, good morning.

Mr. DAVID WESSEL (Deputy Washington Bureau Chief, Wall Street Journal): Good morning.

INSKEEP: Let's start with a basic question. First, how much of the average American's wealth is tied up in their home?

Mr. WESSEL: A huge amount. I mean, nearly 70 percent of all Americans own their own house today, and it's typically their very largest asset. And when the Federal Reserve did its latest calculations, they say that the net worth of the average homeowner is $185,000, but the net worth of the average renter is only $4,000.

INSKEEP: Wow. So, a huge amount of net worth in the house, there. And we should mention that, in recent years, a lot of those Americans have been feeling rather wealthy, haven't they, because home prices have gone up and up and up.

Mr. WESSEL: Right. It's not only feeling wealthy, they have been wealthy. One of the changes in the economy in the last decade is it's very easy to take out your home equity and spend it without selling your house. In the old days, you had to sell your house, and then you had the cash, and you could use that to buy a retirement village, or a car, or a vacation. But now you can pull it out in the form of a home equity loan, and that was really one of the most important drivers of consumer spending over the last decade.

When wages at the middle didn't go up very fast, people were able to keep spending, because they could essentially pull home equity out of their houses.

INSKEEP: Well, what happens now if prices stop going up, or start going down?

Mr. WESSEL: Well, that's a good question, and it's one that when Ben Bernanke, the new Fed chairman, testified on Capitol Hill, and he listed the things that worried him, that was one of his big worries, that the housing market would slow. Now, the effect really depends, first, on how much it slows. Obviously, a flattening is one thing, a crash is another. A crash seems unlikely.

But there's a really interesting debate among thoughtful economists about how bad this is. One group, there happened to be some people at Goldman Sachs, say that if housing prices just flatten, that would mean a big downward pressure on consumer spending, and it will hurt. Other economists, there's a group at JP Morgan, say that, actually, it's okay if housing slows, because consumer spending will keep going as long as wages climb, interest rates don't get too high, the stock market goes on. They say that this really isn't so important. And that's really one of the big questions about the economy this year, is how much will a slow down in housing hurt consumer spending?

INSKEEP: Okay. Let's go a little deeper in the dismal science here. How does anybody figure out, or at least make a reasonable prediction of whether a change in housing prices would affect consumer spending?

Mr. WESSEL: It seems to me from the recent evidence that housing equity has been a huge driver of consumer spending, and there's every reason to believe if housing prices level off, that Americans will spend a little less. The question really is how much is a little less?

INSKEEP: Is this a good point to ask, if in the end, it's really all about faith, or about salesmanship.

Mr. WESSEL: What's hard to figure out in the housing market is how much is reasonable supply and demand, people making sound investments, and how much is the kind of speculative bubble where people are buying houses in the anticipation that it will be worth a lot more a year from now, and they can sell it? But it's very hard to determine how much of what's gone on recently, and how much is going on now is that sort of gambling aspect, and how much is simply the desire of Americans to have bigger and better homes, which seems to be very strong?

INSKEEP: David Wessel of the Wall Street Journal. Thanks very much.

Mr. WESSEL: Thank you.

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