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Why home price increases are not helping the economy

The return of the housing market was supposed to mean the economy was coming back, too. So why is it that even though home prices are rising the economy is as moribund as ever?

There are really two reasons -- both of which show why housing isn't going to be the engine pushing this recovery. First, there is less to the increase in home prices than it appears. Second, the people buying houses now are very different from the people who bought in the run up to the financial crisis.

Yesterday the National Association of Realtors said March pending home sales fell 7.9 percent year-over-year. There was some good news, though: March pending sales were up 3.4 percent month-over-month, the first time that has happened since last summer. Today's S&P/Case-Shiller composite index of 20 metropolitan areas showed a very modest seasonally adjusted increase of 0.8 percent in February. It too has some apparent good news: Year-to-year numbers showed a 12.9 percent increase.

Unfortunately, even the good price increase numbers are likely weaker than they appear.

"The CS (Case-Shiller) data do not properly account for shifts in the share of foreclosure sales, which typically take place at much lower prices than regular sales," Ian Shepherdson, chief economist for Pantheon Macroeconomics, wrote in a note to investors. "We think the underlying trend in home prices already is much weaker than CS suggests; they are probably falling slightly, seasonally adjusted."

Shepherdson says by the end of the second quarter he expects the year-over-year increase rate to slow to about 6 percent to 8 percent. That means month-to-month prices will no longer be rising at all.

Some analysts see an upside to this. "Prices have been growing at gangbuster rates for nearly a year," said economists Paul Edelstein and Ozlem Yaylaci of IHS Global Insight in a research note. "The slowdown, which was expected, is in line with underlying fundamentals. It will help empower buyers to purchase existing homes, thereby fueling residential investment."

Even if the decrease does bring out more buyers Shepherdson and analysts still don't expect that to help the economy by spurring an increase in consumer demand. In the past it did so by letting lower income, lower credit-score households borrow and spend money against the increasing home equity value. This was a major cause of the overheated economy of 2002 to 2007.

"In 2005 and 2006, homeowners refinanced over $600 billion in mortgages where cash was taken out," professors Atif Mian and Amir Sufi wrote in a recent blog post. "What about the 2012 and 2013 period? There was a much smaller volume of cash-out refinancing. Despite home values rising more from 2011 to 2013 than from 2005 to 2006, homeowners took much less equity out of their homes compared to the earlier period. While this doesn't directly measure spending, our research shows that almost all spending during the 2005 and 2006 period came out of active home equity withdrawal. So the fact that there has been very little cash-out refinancing in 2012 and 2013 tells us that there is likely very little spending out of housing wealth currently."

The fact is that rising house prices have much less impact on the economy than they did before the Great Recession. In part, that comes down to who is now buying houses: Many buyers are investors who frequently make money by turning the housing into rental units, not by borrowing against the homes.

As Pantheon's Shepherdson notes, "It is very clear that the huge, sustained increase in prices during the boom was responsible for much of the rise in consumption as a share of GDP, and the plunge in home prices helped stop spending in its tracks by cutting off the flow of home equity extraction. But the rebound in home prices over the past two years has not made any real difference to the path of consumers' spending, as far as we can tell, even though the proportion of underwater mortgages has fallen by almost half."

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