If rising home prices helped the economy bounce back from the dot-com stock market crash by allowing homeowners convert their growing equity into disposable cash, falling home prices will only exacerbate the current downturn by reining in consumer spending, a new study suggests.

The study, by economists at the USC Lusk Center for Real Estate and the UCLA Ziman Center for Real Estate, found that between 1989 and 2001, changes in housing wealth had about three times the impact on consumer spending as other sources of wealth, such as stock holdings.

If rising home prices helped the economy bounce back from the dot-com stock market crash by allowing homeowners to convert their growing equity into disposable cash, few are counting on such relief today. A new study suggests that falling home prices will only make the current economic downturn worse, by significantly reining in consumer spending.

The study, by economists at the USC Lusk Center for Real Estate and the UCLA Ziman Center for Real Estate, found that between 1989 and 2001, changes in housing wealth had about three times the impact on consumer spending as other sources of wealth, such as stock holdings.

The study concluded that a 10 percent decline in housing wealth may reduce consumer spending by $105 billion — the equivalent of a 1 percent reduction in real gross domestic product growth.

During the housing boom, many homeowners used their homes like ATM machines, converting paper gains in equity created by rising home prices into cash to finance purchases of cars, appliances, and other goods and services that might otherwise have been beyond their means.

But it’s hard to say how prevalent the practice was, because home equity can be more difficult to tap than other forms of financial wealth. In order to realize paper gains created by rising home prices, homeowners must either sell their homes or take out a home equity or cash-out refinance loan.

The study, "Housing Wealth, Financial Wealth and Consumption: New Evidence from Micro Data," attempts to more precisely quantify the link between rising and falling home prices and consumer spending.

Rising home prices helped offset the impact on consumer spending of the dot-com stock market collapse, which "destroyed more than $8 trillion in paper wealth and was arguably the cause of the 2001 recession," the paper notes.

U.S. home prices doubled in the 1990s and doubled again from 2000 to 2005, the study notes. Home equity grew by approximately $9.6 trillion from 2001 to 2004, comprising more than half of a typical household’s wealth.

To tap into that equity, many homeowners obtained "cash out" refinance loans, totalling $688 billion from 2001 through 2003, the study said, citing previous research.

Real estate wealth accounted for 12.25 percent of the growth in personal consumption expenditures from the first quarter of 2001 to the third quarter of 2005, the study said, or 9 percent of U.S. gross domestic product.

With home prices continuing to fall, the paper suggests that no such boost in personal consumption can be expected during the current economic downturn.

Given the study’s findings on how housing wealth affects consumer spending, a 10 percent decline in housing wealth from 2005 levels "would be roughly equivalent to a 1 percentage point reduction in real (gross domestic product) growth, a sizable reduction from the approximate 4 percent real GDP growth estimated for recent years."

A 20-city home-price index published by Standard & Poor’s/Case-Shiller showed home prices were down 16.6 percent in August from a year ago (see story).

Since peaking in 2006, national home prices have fallen by 22 percent, according to analysts at Fitch Ratings, who expect an additional 10 percent decline over the next 18 months before prices bottom (see story).

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