by Calculated Risk on 9/26/2005 09:51:00 PM

Greg Ip writes at the WSJ:

]"Federal Reserve Chairman Alan Greenspan, drawing on new research he has personally supervised, said American consumers have become enormously dependent on borrowing against their homes to fuel their spending, and that a rise in mortgage rates could trigger a spending pullback.

Mr. Greenspan's new data show that borrowing against home values added a stunning $600 billion to consumers' spending power last year, equivalent to 7% of personal disposable income -- compared with 3% in 2000 and 1% in 1994.
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That reversal need not be "disruptive," Mr. Greenspan said. Indeed, he suggested that such a reversal would bring about a needed rise in U.S. saving and a narrower trade deficit. But he also sounded new warnings about speculation in the housing market, focusing on rising sales of second homes, though also playing down the threat of overleveraged homebuyers.

Mr. Greenspan's remarks were among his most extensive to date on the scope and risks of the rise in housing prices and mortgage debt in the past decade, developments to which his own policies have contributed. The remarks suggest that while in the near term higher energy prices may be the greatest threat to consumers, in the longer term Mr. Greenspan sees a cooling housing market as potentially more significant.

Last year's estimate of the value of "home equity extraction," as Mr. Greenspan calls it, was double the value of President Bush's tax cuts, as estimated by Brookings Institution scholar Peter Orszag. It's unclear how much of that home-financed borrowing was spent on goods and services, but Mr. Greenspan suggested it was about half.
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Mr. Greenspan also repeated his warnings on the increased popularity of some exotic mortgages, which expose the borrower to a greater risk of rising rates or declining home prices.
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Mr. Greenspan believes this home-equity extraction has been a powerful channel of support to the economy in recent years. Indeed, he believes it's how the Fed's low interest rates propped up the economy after the stock bubble burst in 2001. While the Fed has raised short-term interest rates since last summer, long-term mortgage rates, which are set by bond investors, have stayed surprisingly low. Thus, home-equity extraction has fueled consumer spending longer than Mr. Greenspan thought likely ...