People have started taking money out of their properties to finance consumption once again. But this is not the good news that it may seem. Back in the fourth quarter of 2003, mortgage equity withdrawal (which is the amount of cash the household sector extracts from its housing stock but does not reinvest in property) hit 9% of post-tax income in the UK, or £17.5bn.
The explanation for this was simple: sharply rising house prices and falling interest rates meant people could extract money from their homes without having to increase their monthly mortgage payments. But the MEW boom was not sustainable and as house price growth flattened and interest rates rose, MEW steadily fell to 3.2% in the first quarter of this year. Then, in what came as a surprise to many, it jumped again to hit £8.7bn, or 4.2% of post-tax income in the second quarter of this year.
So what's going on? First let's look at the collapse in MEW until the last quarter. Some economists, myself included, believe that it has profound implications for consumption. Others think that money withdrawn from property has not been spent, but saved in the form of financial assets and that any fall will therefore have little impact on spending going forward. This is the view championed by Professor Stephen Nickell, a member of the Bank of England's Monetary Policy Committee. Nickell claims that MEW simply reflects last-time sellers' (pensioners moving to residential care, or inheritors) moving out of the housing chain and using the proceeds for saving or investing, rather than spending. Thus, says Nickell, whereas household sector debt grew from 7.9% of post-tax income in 1998 to 17.4% by 2003, over the same period financial assets grew from 7.3% to 15.7% of post-tax income. The debt belongs to first-time buyers and the savings to the last-time sellers.
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This argument sounds reassuring, but it just doesn't stack up. If MEW merely reflected last-time sellers taking their money off the housing conveyor belt as first-time-buyers got on, the numbers wouldn't vary much. But they do vary - enormously. While the average level is 2.5%, MEW can soar to 8%-9% of post-tax income or slump into negative territory.
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The other glaring weakness in Nickell's rather complacent argument is that he has cherry-picked his numbers to support his case. Take any other period over the last 15 years or so and you will find that the increase in debt levels and increase in financial assets do not match up in anywhere near such a convenient way. Instead, the rise in debt is consistently greater than the rise in the level of financial assets, which suggests that a great deal of MEW is not saved, but spent. Look at it like this and it is clear that MEW is intimately connected to consumption. Over the last year, retail sales have collapsed just as MEW has.
So if falling MEW is bad news, should we see the recent rebound in MEW as good news? Unfortunately not. What we could easily be seeing is the desperation phase (before the bankruptcy stage) of the more stretched cohorts of the mortgaged classes. If, instead, we assume MEW has for some years been used to subsidise the cost of living, then it makes sense that it should have ceased once rates were rising and house prices stalled because then borrowing more would have meant rising mortgage bills. However, if you aren't raiding the housing pot to spend, you have to spend less. Some have - hence the sharp fall off in retail sales - but others appear to have found it impossible and have hence made a forced return to MEW (even though MEW hurts them more than it did). This latter group are now in a bind. In the past, the value of their house has kept rising and so, accordingly, has their available borrowing pot, meaning that they could always go back for more. But now, flat house prices mean those happy days are over. If they don't rein in their spending, then the next stop is the bankruptcy court.
This explanation also seems to fit the evidence. Retail sales are collapsing, and if you look to history you will see that the recent rebound in MEW is nothing new. Take the last housing crash. MEW peaked in the third quarter of 1988 and by early 1989 was falling fast. Then, in the third and fourth quarters of 1989, just as house prices were turning negative, MEW briefly rallied, even though by this time interest rates were double what they'd been the year before.
Then, as now, the late cycle rebound in MEW didn't reflect falling borrowing costs, nor was it facilitated by rising house prices. No, at this stage of the cycle it is now most likely that it reveals the desperation of those who can only finance their lifestyles through debt. But this time, MEW will entail higher monthly service charges and the bank may not be so keen to lend as the value of the collateral stalls. To increase borrowings to be able to afford the mortgage payments is obviously an unsustainable strategy. For those who don't, or can't, cut back expenditure, this rally in MEW is the harbinger of the twin evils, so rarely mentioned for the last few years, of repossession and personal bankruptcy.
