What happens when housing's 'wealth effect' dries up?

Tuesday, 28 March 2023

The rate of house prices falls more than tripled in February compared to January, CoreLogic data shows.

For years, it has been easy for homeowners to watch house prices rise feel wealthy, and go out and spend.

Sometimes that spending has been backed by home loan “top ups” that are possible because of the increase in homeowners’ equity. Other times, people just feel more confident in taking out other loans.

Some economists consider this “wealth effect” a boon to the economy, as that spending translates to more economic stimulus.

But capital gains are only on paper until the home is sold, while the debts taken on in “wealth effect” spending are real and require servicing with regular repayments.

Loan arrears rates are already up, hitting a three-year high recently, and in February 430,000 Kiwis were behind on their bills, according to Centrix data.

* Business defaults in Auckland and Northland reflect lockdown distress -

* Jump in number of Auckland businesses shutting doors in lockdown, data shows

The credit reporting company also recorded 18,400 were behind on their home loans in the same month.

Centrix data allows another insight – by comparing the size of loans Kiwis have been taking on to CoreLogic’s Housing Price Index, it shows Kiwis have been taking on progressively larger consumer loans and more credit card debt as house prices ticked up.

Centrix general manager of analytics Stuart Baxter said the closeness of correlation was surprising, but the trend was not unexpected, particularly as inflation would increase the size of loans.

To some extent, he said, the correlation hinted the wealth effect was at work, likely in part due to the consumer confidence boost that followed from rising house prices.

Baxter said there was evidence Kiwis were turning more to personal loans as they struggled with the cost of living, so the upward trend of loan sizes may continue upwards even as house prices fell, creating a new divergence of the metrics.

Centrix managing director Keith McLaughlin said it was more helpful to think of the country as having two very separate and distinct economies.

In the graph, the green line reflects the average size of loans taken on by Kiwis (other than home loans), which included personal loans, vehicle loans and credit cards.

The first is those who have owned their homes for a while, primarily those who bought pre-pandemic.

For these people, their homes are still worth far more than the price they paid for them, and they will have paid down more of their mortgages.

This group would probably continue to spend, he said.

The second group is made up of more recent buyers, who bought around the peak of the market and have watched their house values fall up to 16%.

This group was likely to be tightening their belts, cutting back on a lot of discretionary spending, and feeling a kind of poverty effect.

New vehicle loans kept trending up during 2022, despite house prices falling, but began to fall in 2023.

“I went in to where I get my coffee the other day and I ask the guy if he was busy, and the guy said no, people just aren’t spending money.” he said.

“So I think it does have an impact, absolutely.”

Another piece of Centrix data appears to suggest less of a correlation between house prices and their willingness to take on debt.

Despite house prices being on an unabated downward trend for over a year, the amount taken out of new vehicle loans kept trending up during 2022, but fell in 2023.

Financial author Martin Hawes was a financial adviser for roughly 25 years.

Baxter said the size of vehicle loans would have been bumped by the general increase in the cost of secondhand vehicles, which was largely due to a lack of supply.

“Given the current economic environment and the uncertainly about where interest rates will move, I think that’s making people increasingly caution in how they manager their finances, so I’d be surprised if we see an expansion in those new car loan markets, and at best we will get a plateau during the rest of this year.”

Financial author Martin Hawes believed there was a backfiring of the wealth effect under way now, and it was only being mitigated by very low unemployment.

“I’ve been doing this for 50 years and as wealth declines, spending tends to dry up.”

Hawes has a close friend who is a car dealer in the mid-market range, who Hawes said had been the best bellwether of what was coming for the economy he had ever had.

“He has had a drop-off for some months, and that’s telling me we are in negative growth at the moment, we might be about to see our first recession in a very long time.”

Infometrics chief forecaster Gareth Kiernan is a firm sceptic of the wealth effect.

“If his bell is ringing as truly as it usually does, I think we are in for a difficult time over the next 12 months.”

He said there had been a lot of stress-testing done on borrowers, so he did not predict any catastrophic effects for those who bowed to the temptation to spend as their house price rose.

“Having said that I would not be at all surprised to see an increase in defaults and arrears, but I don’t think it’s going to be anything like the result of 1987 crash where a lot of people lost their houses.”

Infometrics chief forecaster Gareth Kiernan described himself as “one of the biggest sceptics of the wealth effect”.

He believed that while house price rises might entice some of the more “cavalier” to go out and spend, most realised they would be buying in the same market when they came to sell, and would act more conservatively.

The correlation between borrowing and house prices was likely due to other forces that influenced the two.

He said previous housing booms happened at times of low interest rates, strong labour markets, and strong income growth – all of which would also encourage people to spend on other things.

Today, Kiernan said with fixed home loan interest rates sitting around 6.5% – which the market hadn’t seen for about seven years - it was unsurprising if spending in all areas dropping.

Other indicators were also pointing to harder times ahead, including hiring intentions among employers, high inflation, and unemployment creeping up, although overall unemployment rates remained low.

The one area where Kiernan does believe the wealth effect comes into play is on home renovations.

He said if an owner saw their house price increase by $200,000 in estimated value, they would likely be happy to spend $100,000 on a renovation.

Kiernan said Kiwi households were also in a historically strong financial position overall, with the lowest rate of interest bearing debt since 2006, possibly as many used the low interest rates of the Covid-era to pay down more of their home loan.

This would suggest they were in a strong position to weather the predicted recession.

Kiernan said a mild slowdown in vehicle purchasing was consistent with other spending indicators he had seen, across things like vehicles, appliances, and furniture.

“These sorts of purchases tend to be more discretionary in nature, and with household budgets being squeezed by higher interest rates and increased living costs more generally, there will typically be more of a focus on ‘essential’ spending rather than the nice-to-haves,” he said.

“Again, it’s hard to dissociate changes in this type of spending from movements in house prices – and therefore the wealth effect – because so often it could be the same driver causing both.”

Economist Tony Alexander agreed with Kiernan, that the wealth effect was small.

“I assign far greater significance to income and expectations of future employment as an influence on consumer spending than changes in asset values,” he said.