WP/06/162
Is Housing Wealth an “ATM”?
The Relationship Between Household Wealth,
Home Equity Withdrawal, and Saving Rates
Vladimir Klyuev and Paul Mills
© 2006 International Monetary Fund WP/06/162
IMF Working Paper
Western Hemisphere Department and International Capital Markets Department
Is Housing Wealth an “ATM”? The Relationship Between Household Wealth,
Home Equity Withdrawal, and Saving Rates
Prepared by Vladimir Klyuev and Paul Mills
1
Authorized for distribution by Tamim Bayoumi
June 2006
Abstract
This Working Paper should not be reported as representing the views of the IMF.
The views expressed in this Working Paper are those of the author(s) and do not necessarily represent
those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are
published to elicit comments and to further debate.
This paper examines the role increasing personal wealth and home equity withdrawal (HEW)
have had in the decline in the personal saving rate in the United States. It does so by
comparing the U.S. experience with those of Australia, Canada, and the United Kingdom.
Mortgage market liberalization and innovation should reduce household cash flow and
collateral constraints while making housing wealth more liquid as HEW becomes easier over
time. Regression analysis indicates the expected negative relationship between U.S. saving
and net worth, with a somewhat smaller coefficient than in previous studies. HEW is
estimated to have a temporary negative impact on saving of the order of 20 cents on the
dollar.
JEL Classification Numbers: E21, G21
Keywords: Household Saving, Home Equity Withdrawal, Housing Finance
Author(s) E-Mail Address: [email protected]; pm[email protected]
1
The authors gratefully acknowledge comments and contributions by Tamim Bayoumi, Kornélia Krajnyák,
Sam Ouliaris, and participants in the IMF seminar; help with data provided by the Reserve Bank of Australia and
Statistics Canada; and excellent research assistance provided by Yoon Sook Kim, Andrew Swiston, and
Volodymyr Tulin. All remaining errors are ours.
2
Contents Page
I. Introduction....................................................................................................................3
II. Have Saving Rates Really Fallen?.................................................................................3
III. Likely Impact of Financial Innovation and Liberalization on Home Equity
Withdrawal (HEW) and Saving............................................................................7
IV. Trends in HEW and Household Saving Across Countries ..........................................11
V. How Does HEW Affect Household Saving?...............................................................13
VI. Econometric Analysis..................................................................................................14
VII. Recent Experience of HEW in Australia and United Kingdom: Implications for
United States? .....................................................................................................18
VIII. Conclusions..................................................................................................................19
Appendices
I. Financial Liberalization and Mortgage Product Innovation........................................21
II. Data Issues ...................................................................................................................22
References................................................................................................................................24
Box
1. Defining Home Equity Withdrawal...............................................................................9
Tables
1. United States: Time-Series Regression Results for Household Saving......................16
2. Canada: Time-Series Regression Results for Household Saving ...............................17
3. Australia: Time-Series Regression Results for Household Saving.............................17
4. United Kingdom: Time-Series Regression Results for Household Saving ................17
5. Panel Regression Results for Household Saving.........................................................18
Figures
1. Household Saving Rates: National Definitions .............................................................3
2. United States: Household Saving Rate Adjusted for Effects of Inflation on Fixed-
Income Assets and Liabilities ...............................................................................5
3. United States: Household Saving Rate Adjusted for Treatment of Rental Expenditure
and Residential Capital Consumption...................................................................5
4. Adjusted Household Saving Rates.................................................................................6
5. Mortgage-Backed Securities as a Share of Mortgages Outstanding..............................7
6. Ratio of Unsecured Credit to Total Household Debt...................................................10
7. Uses of Net Saving.......................................................................................................12
8. House Price Increases and Consumption Growth........................................................19
9. Australia and United Kingdom: House Prices and Home Equity Withdrawal............19
3
Figure 1. Household Saving Rates:
National Definitions
-5
0
5
10
15
20
25
1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005
-5
0
5
10
15
20
25
(percent of disposable income)
A
ustralia
United Kingdom
Canada
United States
Source: Haver Analytics.
I. INTRODUCTION
“It’s like installing an ATM on the side of your house.” Loan advertisers and financial
commentators have been quick to identify the rise in additional secured borrowing in the
United States with withdrawing housing equity to finance consumption. The former laud the
flexibility of borrowing against housing collateral to consume; the latter fret that U.S.
households are overstretching by adding to their debt burdens and eroding the equity in their
houses. The decline in the U.S. personal saving rate, such that households are now
consuming more than their disposable incomes, is readily ascribed to the rise of home equity
withdrawal (HEW).
This paper assesses whether reality matches this perception. First, does the negative U.S.
household saving rate (hereafter referred to simply as saving) reflect reality or is it a
statistical artifact? Second, what role, if any, has financial liberalization played in reducing
U.S. saving and fostering HEW? Third, to what degree have increasing housing wealth and
HEW been responsible for the decline in U.S. saving?
The paper addresses these questions, comparing the U.S. experience with those of Australia,
Canada, and the United Kingdom to see if other countries with competitive mortgage markets
and similar home-ownership rates provide additional insight into the interaction of housing
wealth and savings. It does so by first describing financial sector innovation in each country,
which helps to calibrate the degree to which constraints on accessing home equity have been
relaxed. The paper then uses regression analysis to draw possible implications for the U.S.
personal saving rate of the slowing housing market.
II. HAVE SAVING RATES REALLY FALLEN?
The household saving rate—the ratio of
household net saving to personal disposable
income—has been on a declining trend in the
United States since the mid-1980s, and finally
turned negative in 2005. Over the last decade,
saving rates have also declined in other large,
industrial economies with “Anglo-Saxon”
financial markets, notably Australia, Canada,
and United Kingdom (Figure 1).
2
Recent declines in saving rates, and particularly
their fall into negative territory, have given rise
to concerns about measurement issues. Some of these are conceptual, questioning whether
the measure employed in the national accounts is appropriate; others are more technical,
2
The household saving rate has declined substantially in New Zealand as well.
4
asking whether changes in the behavior of certain macroeconomic variables may have
affected the measured saving rate without genuine changes in household behavior.
The main conceptual issue is whether saving should be calculated as the difference between
disposable income and consumption (a flow measure) or as a change in the household net
wealth (a stock measure). This is a long-standing issue (see, for example, Hicks, 1939). The
main argument of statistical agencies (Perozek and Reinsdorf, 2002), which report the flow
measure in national accounts, is that it is appropriate for measuring funds available to finance
new investment, while valuation changes, which account for the difference between the stock
and the flow measures, do not create “real wealth.”
Although generally applicable, this argument does not hold in some instances. For example,
if dividends paid by firms to households are banked and then on-lent to firms to expand
capacity, household wealth and saving will increase by the amount of the dividend. If firms
invest out of retained earnings rather than paying dividends, however, household wealth still
increases as stock prices rise, reflecting the value of the investment, but measured saving
rises in the corporate, rather than household, sector. As another example, an increase in net
financial claims on foreigners owing to valuation changes may be considered accumulation
of real wealth for residents.
One might also assert that flows largely reflect underlying household decisions, while
changes in stocks are affected by volatile movements in market prices. This could reduce the
stock measures’ usefulness as an indicator of underlying trends in the economy. In addition,
given the volatility of asset prices, the marginal propensity to consume out of income is much
larger than that out of wealth, since households treat unrealized capital gains as potentially
transient. A final aspect of capital gains is that they have to be realized to provide funds
available to fund expenditure, although as a consequence of financial market development,
including home equity withdrawal, this is less of an issue.
We do not take a position in this debate, since the purpose of the paper is to explain
movements in the measured flow saving rate. We note, however, that the household saving
rate as defined by national accounts may well decline in periods of rapid asset price
appreciation without driving down the ratio of household net worth to disposable income.
Another well-recognized conceptual issue has to do with the erosion of the real value of fixed
nominal assets owing to inflation (Jump, 1980). As inflation goes up, the interest rate also
increases, pushing up both disposable income and saving by the same amount, assuming
there is no change in real consumption. The result is that one tends to observe higher saving
rates in periods of high inflation. The correlation, however, is spurious,
3
as the inflation
3
The link considered here is purely mechanical. There may be a behavioral change if households raise
precautionary saving, since higher inflation typically means more uncertainty.
5
component of higher interest receipts represents not return on investment but rather return of
investment, that is compensation for the erosion in the real value of financial assets.
4
A simple adjustment subtracts the product of the inflation rate and the stock of fixed-income
assets from disposable income and from net saving and adds the product of the inflation rate
and the stock of liabilities to net saving. As Figure 2 demonstrates, this adjustment indeed
lowers the U.S. saving rate perceptibly in the high-inflation period of the 1970s–1980s. The
adjustment changes sign at the end of the
1990s, as the stock of household fixed-income
assets falls below that of liabilities. At the
same time, the adjustment is clearly
insufficient to account for more than a small
fraction of the decline in the saving rate. This
conclusion pertains to the other three
countries as well.
There are also technical concerns related to
asset price inflation. First, although realized
capital gains are not included in household
income, taxes on them are deducted, driving
down disposable income and the saving rate.
According to Reinsdorf (2004), capital gains
taxes equaled 1.65 percent of U.S. household
disposable income in 2000, at the peak of
realized holding gains, and their increase
contributed 0.5 percentage point to a
5.9 percent decline in the saving rate between
1992 and 2001. The importance of capital
gains taxes declined after the bursting of the
dot-com bubble, and so has the wedge
between the standard measure of household
saving and the one that does not subtract capital gains taxes.
5
Second, an increase in house prices drives up imputed rents and consumption of fixed capital,
lowering the saving rate even if there is no change in household behavior. A simple way to
4
Looking at a ratio of real household saving to real disposable income would not solve the problem, since both
saving and income would be deflated using the same price index, and the ratio would not be affected. The issue
is that consumption expenditure and non-asset income are proportional to the price level, while the inflationary
component of interest receipts and payments is proportional to the rate of price increases.
5
The reduction in realized capital gains may explain some of the sideways drift in the household saving rate
early in this decade before the plunge in 2004–2005.
Figure 2. United States: Household Saving Rate
A
djusted for Effects of Inflation on Fixed-Income
Assets and Liabilities
-2
0
2
4
6
8
10
12
14
16
1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005
-2
0
2
4
6
8
10
12
14
16
(percent of disposable income)
Unadjusted saving rate
A
djusted saving rate
Unadjusted minus adjusted
Inflation (y/y percent
change in CPI)
Sources: Haver Analytics; and IMF staff calculations.
Figure 3. United States: Household Saving Rate
Adjusted for Treatment of Rental Expenditure
and Residential Capital Consumption
-2
0
2
4
6
8
10
12
14
16
1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005
-2
0
2
4
6
8
10
12
14
16
(percent of disposable income)
Unadjusted saving rate
A
djusted saving rate
A
djusted minus unadjusted
Sources: Haver Analytics; and IMF staff calculations.
6
judge the importance of this effect is to examine the evolution of the ratio of gross saving to
the difference between gross disposable income and imputed rent. Figure 3 shows that such
an adjustment raises the U.S. household saving rate by a remarkably stable amount, so the
previously mentioned factors do not help explain the evolution of the measured saving rate
over time.
Other corrections considered in the literature, such as splitting personal income and saving
into those of households and nonprofit institutions serving households or excluding defined-
benefit pension plans from the personal sector, also have little impact on the measured fall in
saving (Reinsdorf, 2004). Thus, we conclude that although a number of factors may have
magnified the decline in the flow measure of the saving rate, the bulk of the decline is real.
Saving ratios for the four countries in our sample, adjusted for consumer price index (CPI)
and house price inflation, are shown in Figure 4.
Figure 4. Adjusted Household Saving Rates 1/
-3
0
3
6
9
12
15
1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005
-3
0
3
6
9
12
15
National definition
A
djusted
Adjusted minus unadjusted
(percent of disposable personal income)
Sources: Haver Analytics; National Sources; and IMF staff calculations.
1/ See the text for a description of the adjustments.
2/ Excludes residential capital consumption allowance from income and saving, as is the case for the other countries.
United States
Canada
Australia
United Kingdom
0
5
10
15
20
25
30
1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005
0
5
10
15
20
25
30
National definition
A
djusted
A
djusted minus unadjusted
(percent of disposable personal income)
-5
0
5
10
15
20
1988 1990 1992 1994 1996 1998 2000 2002 2004
-5
0
5
10
15
20
National definition
A
djusted
A
djusted minus unadjusted
(percent of disposable personal income)
-3
0
3
6
9
12
15
1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
-3
0
3
6
9
12
15
National definition 2/
A
djusted
A
djusted minus
unadjusted
(percent of disposable personal income)
7
III. LIKELY IMPACT OF FINANCIAL INNOVATION AND
LIBERALIZATION ON HOME EQUITY WITHDRAWAL (HEW) AND SAVING
Saving behavior, especially ‘buffer-stock’ saving, will be affected by the ease with which
households can borrow to finance consumption or durable and house purchases. Financial
liberalization and innovation in the provision of borrowing facilities to households eased
these constraints in the four countries under consideration (see Appendix I). Initially,
measures concentrated on relaxing controls on the ability of financial institutions to attract
deposits or to satisfy the potential demand for credit. Liberalization of deposit and lending
markets permits intermediaries to raise finance more cheaply and satisfy loan demand if their
expected rate of return on capital justifies the extension of their balance sheets and
commitment of scarce capital.
Also, a reduction in mortgage and refinancing transaction costs can be achieved by
increasing competition in loan markets (through new entrants, foreign competitors, and new
technology). Competition can be facilitated by the entry of purely wholesale-financed lenders
unconstrained by the sunk costs required to attract retail deposits, and by mortgage brokers
originating mortgages to be securitized in pools of loans backing mortgage-backed securities.
The ability of lenders to securitize mortgages (and other consumer loans) allows access to a
wider range of investor capital, increases the ability of lenders to manage their capital and so
potentially reduces the cost of mortgages.
6
One indication of the competitiveness and
potential for innovation on the mortgage
market is the degree to which the stock of
mortgages has been securitized. As
illustrated by Figure 5, U.S. mortgage
securitization expanded rapidly in the 1980s
and 1990s so that mortgage-backed securities
(MBS) now finance around 60 percent of the
U.S. mortgage stock. Elsewhere, MBS
markets have only grown rapidly in the last
decade. The Australian market increased
from around 3 percent of mortgages outstanding in the mid-1990s to around 22 percent in
2006 while that in Canada grew from 4 percent to around 16 percent in the same period.
While no time series is available to show the trend, MBSs were first issued in the United
Kingdom in the late 1980s and accounted for 12 percent of the mortgage stock by the end of
2004 (CML, 2005, p.6), a similar ratio to that of Canada.
6
A possible adverse effect of securitization is to increase credit rationing for those borrowers whose
characteristics do not meet the criteria needed for eligibility into the pools of mortgages to be securitized.
Figure 5. Mortgage-Backed Securities as a
Share of Mortgages Outstanding
0
10
20
30
40
50
60
70
1976 1980 1984 1988 1992 1996 2000 2004
0
10
20
30
40
50
60
70
A
ustralia
Canada
United States
(percent)
Sources: Board of Governors of the Federal Reserve
System; Reserve Bank of Australia; and Statistics Canada.
8
In addition, advances in credit scoring techniques (through the greater availability of data on
pools of borrowers) have reduced default risk premia while search costs have fallen through
the development of the internet and competition amongst mortgage brokers.
7
These
developments have helped to ensure that access to credit is extended to borrowers of more
marginal creditworthiness.
Financial innovation, competition, and technological advance should therefore have a
number of effects on the housing market. First, liberalization increases the access of
marginally creditworthy borrowers to loans and reduces the need for first-time buyers to save
for substantial down payments.
8
Second, transaction and search costs are lowered for taking
out a mortgage, refinancing it and moving house. Third, borrowing against existing collateral
(e.g., through home equity loans or second mortgages) should be cheaper and available to
more households, thus increasing the accessibility of accumulated housing equity. As credit
rationing constraints are relaxed, increasing the supply of credit for any given interest rate, it
is likely that both consumption and house prices will rise simultaneously. Hence, financial
liberalization and innovation can itself help drive the saving ratio down.
Such financial innovation should also allow greater flexibility for households to smooth
consumption through time when income is expected to grow; enable households to borrow to
maintain consumption when income is subject to shocks; and increase the liquidity of
housing wealth relative to financial assets. Hence, one would expect mortgage innovation to
lead to a higher and less volatile average propensity to consume from income, and an
increase in the value of housing as an investment asset as its liquidity increases.
9
By relaxing
immediate cash flow constraints and providing greater flexibility over the interest paid in the
immediate future, such changes may also soften the immediacy of the elasticity of
consumption with regard to changes in nominal interest rates. Part of this smoothing will
occur through HEW.
7
See Frankel (2006) for a discussion of how the credit scores of mortgages backing non-agency MBS have
declined markedly between 2000 and 2005.
8
Frankel (2006) shows how the share of ‘prime’ mortgages backing U.S. non-agency MBS issuance has fallen
from around 50 to 25 percent since 1995 as ‘Alt-A’ and subprime lending has grown. Subprime loans now
constitute 9 percent of U.S. securitized mortgage debt and financed 15 percent of home sales in 2005 (JP
Morgan, 2006, p.29).
9
Boone, Girouard, and Wanner (2001) find that financial deregulation and innovation raised the marginal
propensity to consume in Canada, the United Kingdom and the United States (Australia was not included in the
sample). Borrowers may also seek to reduce interest costs by refinancing unsecured consumer credit through
cheaper secured debt, especially if interest on mortgage debt is tax advantaged relative to unsecured debt (as it
has been in the U.S. since the Tax Reform Act of 1986).
9
Box 1. Defining Home Equity Withdrawal
Home equity withdrawal (HEW) is the generic description for transactions whereby
homeowners collectively reduce the equity in their homes. HEW can arise as the result of
housing transactions, additional borrowing, or a combination of the two. HEW rises when
homeowners:
• Take out a mortgage with a value in excess of that of the house;
• Exercise negative amortization options, thereby increasing their debt;
• Remortgage or refinance their existing mortgage with a higher principal;
• Take out a second mortgage or home equity loan;
• Increase their mortgage indebtedness when moving into a new house of similar value;
• Trade down to a lower-value house when they have no mortgage or while maintaining
their level of secured debt;
• Sell a house, repaying any mortgage, to move into rental accommodation or realize a
bequest.
Conversely, households inject equity into their holdings of housing wealth when they:
• Make a down payment on a first-time purchase;
• Make amortization and additional payments on a mortgage or home equity loan;
• Remortgage, or refinance their existing mortgage, with a lower principal;
• Reduce their mortgage indebtedness when moving into a house of similar value;
• Purchase second homes and investment properties with cash;
• Finance home improvements other than through a mortgage.
Net HEW is the difference between these two measures. When home improvements are
financed through secured borrowing, there should be no impact on net HEW.
As can be envisaged from the components of HEW (see Box 1), it is often strongly linked
with the level of housing transactions and increasing housing equity due to price
appreciation. Indeed, a substantial component of gross HEW has been extracted as a result of
housing turnover in the United States since the mid-1990s (Greenspan and Kennedy, 2005).
However, HEW has been also been found to be strongly positively correlated with the degree
of mortgage market completeness (Catte and others, 2004).
10
Financial liberalization and
innovation makes HEW easier by:
10
This study examined the degree to which HEW as a proportion of disposable income was related to a
constructed indicator of mortgage market completeness in eight European Union countries from 1990 to 2002.
10
• Reducing the delay and transactions costs of refinancing. Innovation in credit scoring
and greater competition has resulted in a sharp fall in the transactions costs of
refinancing.
11
As a result, households are more likely to refinance their fixed rate
loans when interest rates fall and when they wish to withdraw equity. Krainer and
Marquis (2003) attribute the far higher rate of U.S. mortgage refinancing in 2001–02
compared to 1990–91, despite a similar decline in long-term mortgage rates, to the
greater build-up of home equity and lower transactions costs. Lower transactions
costs also increase the ‘churn’ rate on house purchases, providing opportunities to
extract equity. The average life of a mortgage in the United Kingdom fell from seven
years in 1995 to three in 2004.
• Introducing flexible mortgage terms. A number of new mortgage products include
cheap or costless options to borrow against existing equity in one’s home. For
instance, in Australia and the United Kingdom, “offset” mortgages, in which
transaction balances are netted off from the borrower’s mortgage debt, provide
flexibility for the debt to rise as long as a degree of equity is maintained in the house.
Similarly, a significant proportion of U.S. mortgages extended in 2004–2005 contain
negative amortization options, so permitting the borrower to increase debt flexibly
against their equity.
• Increasing access to second mortgages and home equity loans. Better credit scoring
and mortgage broker competition have increased access to, and lowered the relative
rate charged on, secondary mortgages. In the United States, this trend has also been
driven by the dramatic growth in the
issuance of securitized pools of home
equity loans (HELs) and lines of
credit (HELOCs), thus reducing their
cost.
12
Since the early 1970s, when
unsecured debt accounted for a third
of U.S. household borrowing, there
has been a trend decline in the share
of unsecured to total household debt
(see Figure 6), encouraged by the
withdrawal of the tax deductibility of
interest on unsecured debt in 1986.
11
In the United States, according to Freddie Mac data, as a proportion of the loan, average fees and points
charged on a 30-year fixed rate mortgage have fallen from 2.5 percent in 1984 to 0.6 percent in 2005.
Consequently, long-term interest rates need to fall significantly less than previously to make it worthwhile for
the borrower to refinance in net present value terms (Bennett, Peach, and Persistani, 2001).
12
Issuance of U.S. HEL and HELOC asset-backed securities rose from $61 billion in 1999 to $515 billion in
2005 (JP Morgan, 2006).
Figure 6. Ratio of Unsecured Credit to
Total Household Debt
10
15
20
25
30
35
40
45
1989 1991 1993 1995 1997 1999 2001 2003 2005
10
15
20
25
30
35
40
45
A
ustralia
Canada
United States
(percent)
United Kingdom
Sources: Board of Governors of the Federal Reserve
System; Bank of England; Reserve Bank of Australia; and
Statistics Canada.
11
This movement has been most pronounced in Australia but has only recently begun to
reassert itself in the United Kingdom and United States following a cyclical upswing.
Canada displays a contrary tendency, with unsecured consumer borrowing growing
strongly relative to mortgage debt due to the absence of cost-effective HEL products.
• Increasing ability to access home equity in retirement. Although not significant in
absolute amounts in any of the four countries, home equity release loans, designed for
older homeowners to generate income in retirement, are beginning to become more
widely available and publicized.
13
Such products enable housing equity to be
converted into income without the need to move home in retirement. Their existence
reinforces the belief that home equity can be used as a supplement to pension savings.
IV. TRENDS IN HEWAND HOUSEHOLD SAVING ACROSS COUNTRIES
One way to examine the link between HEW and saving is in the context of an accounting
relationship between national accounts and flow-of-funds accounts. In principle, net saving
should equal the increase in net assets, real or financial, although in practice the two are
somewhat different since they are estimated from different sources.
14
Figure 7 shows the
decomposition of household net saving into net home equity injection (the difference
between net investment in housing and net borrowing secured on housing, that is HEW with
the sign reversed) and net flow into financial assets (net acquisition of financial assets minus
net nonsecured borrowing). One can observe substantial differences across countries.
In the United States, from 1961 until the mid-1990s, HEW was fairly small relative to
household income and switched from negative to positive and back, moving, if anything, in
the same direction as the saving rate. It is only in the last ten years that a pronounced growth
in the HEW ratio has coincided with a decline in household saving. At the same time, flows
into net financial assets tended to rise, at least after the collapse of the IT bubble, giving
credence to the claim that HEW was largely used for portfolio rebalancing (paying off more
costly nonsecured debt and moving wealth from residential to financial assets).
13
Such schemes generally take one of two forms. A home reversion plan entails a homeowner selling all or part
of their home for a lump sum with the right to remain in occupation. On sale, the lender receives their equity
share of the proceeds. A lifetime mortgage involves the borrower remortgaging their house to take a cash lump
sum or annuitised income stream. Interest accumulates and is settled on the sale of the property. In the United
Kingdom, roughly £1¼ billion p.a. of home reversion mortgages and home income plans were sold in 2003–
2005 (FSA, 2006).
14
This analysis uses comparable definitions across countries, hence it does not necessarily reproduce national
data.
12
Figure 7. Uses of Net Saving
Sources: Haver Analytics; National Authorities; IMF Fund staff calculations.
-20
-15
-10
-5
0
5
10
15
20
25
1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 200
5
Net home equity injection Flow into net financial assets Net saving
(percent of disposable income)
-20
-15
-10
-5
0
5
10
15
20
25
1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 200
5
Net home equity injection Flow into net financial assets Net saving
(percent of disposable income)
-20
-15
-10
-5
0
5
10
15
20
25
1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 200
5
Net home equity injection Flow into net financial assets Net saving
(percent of disposable income)
-20
-15
-10
-5
0
5
10
15
20
25
1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 200
5
Net home equity injection Flow into net financial assets Net saving
(percent of disposable income)
United States
Canada
Australia
United Kingdom
13
Canada is unique among the four countries in that is has not witnessed substantial home
equity withdrawal. Moreover, in the last few years home equity injection has picked up
noticeably, in a development possibly related to a housing boom in western Canada. Rather,
the decline in household saving has reflected diminishing flows into financial assets.
Both Australia and the United Kingdom featured substantial home equity withdrawal in the
short periods for which data are available. In Australia, HEW has increased while the saving
rate has declined since the late 1970s, although fluctuations of the two variables have not
been synchronous. In the United Kingdom, HEW and the saving rate have generally moved
in opposite directions since the late 1980s. Both countries have recently experienced a sharp
reduction in house price appreciation, which was associated with some decline in home
equity withdrawal and stabilization of the saving rate. Flows into net financial assets have not
exhibited an apparent trend in either country.
V. HOW DOES HEW AFFECT HOUSEHOLD SAVING?
Two schools of thought have emerged that differ in the influence on consumption they
ascribe to HEW. One believes that the strong negative correlation of HEW with saving rates
(particularly in the United States since the mid-1990s) indicates causation and that HEW has
a strong influence in driving consumption growth. This school expects there to be a strong
impact on consumption if the U.S. housing market slows and HEW declines sharply. The
other school regards any such correlation as being largely driven by independent factors that
lead to rising HEW and falling saving (e.g., rising income expectations or a positive house
price shock). According to this line of argument, while undoubtedly some proceeds from
HEW find their way into immediate consumption, the direct impact is not likely to be
substantial. Any increase in U.S. saving as a result of a cooling housing market will arise
from households’ reaction to lower wealth rather than lower HEW.
Previous literature provides mixed messages. In two cross-country OECD studies (Boone,
Girouard, and Wanner, 2001; Catte and others, 2004), HEW is found to be strongly
positively associated with a high estimated marginal propensity to consume from housing
wealth. Indeed, Catte and others (2004) find that HEW dominates housing wealth as a driver
of consumption, with 89 percent of HEW estimated to be consumed in the United Kingdom,
63 percent in Canada and Australia, and 20 percent in the United States.
Conversely, survey evidence from homeowners about their motives for extracting home
equity indicates that limited proportion is used to finance immediate consumption, although
it may boost residential investment through home improvements. A 2004 survey of
Australian homeowners found that the bulk (72 percent) of HEW was extracted via property
transactions, principally through older owners selling to younger buyers with larger
mortgages. Two-thirds of HEW was used to acquire financial assets or pay off debts with
household expenditure accounting for 18 percent (RBA, 2005). A similar picture is painted
by a U.K. survey of households conducted in 2003. The majority of HEW arises from
14
housing transactions with the most commonly cited motive being to save or pay off other
debts. Expenditure was, however, a significant reason for many of those withdrawing equity
through second mortgages or refinancing, primarily for the purpose of home improvement
(Benito and Power, 2004).
15
U.S. survey evidence for the uses of some types of HEW comes from questions posed to
householders concerning the use of funds released from cash-out refinancing (Canner,
Dynan, and Passmore, 2002). Within the survey period (2001–2002H1), 45 percent of those
who refinanced their mortgage extracted equity, amounting to an estimated $132 billion. Of
this HEW, 35 percent was used on home improvements, 26 percent for the repayment of
debt, 21 percent for the acquisition of real assets, and 16 percent to finance consumers’
expenditure.
Although the format of these surveys differs across countries, a similar picture emerges. This
is one of HEW primarily occurring to the greatest extent through housing transactions rather
than homeowners increasing their mortgage debt with households using the equity extracted
primarily to acquire financial assets or repay other debts. Spending intentions were focused
principally on home improvements (leading to no net effect on HEW) with usually less than
20 percent used to finance consumption. Hence, although some HEW is consumed, it appears
to be used primarily as a tool for acquiring financial assets, repaying more expensive debts,
or improving the housing stock.
VI. ECONOMETRIC ANALYSIS
This section uses an econometric model to explore the reasons for the decline in the
household saving rate and the role HEW might play, focusing on four explanatory variables:
net worth as a ratio of personal income, the short-term real interest rate, inflation, and HEW
as a proportion of personal income. As indicated above, rapid asset price appreciation may
leave household wealth unchanged or even rising relative to income, even as the saving rate
goes down. In a life-cycle model, such as that by Galí (1990), an increase in wealth relative
to income would induce households to increase their consumption relative to income,
financing it out of wealth, and thus bring down the saving rate. The effect of an increase in
the real interest rate on saving theoretically is ambiguous, as the higher reward for saving
may be offset by an income effect if net financial assets are positive, but most empirical
studies have found the substitution effect to dominate. Higher inflation is expected to be
associated with higher saving, both owing to the need for the households to compensate for
the erosion in the real value of their assets, as discussed above, and, possibly, due to
precautionary saving in the face of heightened uncertainty. Also, the saving rate may exhibit
15
In addition, the Dutch National Bank surveys households in the Netherlands annually to assess their use of
HEW (van Els, van den End, and van Rooi , 2005). In 2003, respondents said that increases in secured debt
were predominantly (70 percent) used for home improvement, followed by savings and investments
(10 percent), consumption (8 percent), and repayment of other debt (6 percent).
15
a downward trend, reflecting financial market development, which relaxes liquidity
constraints and reduces the need for precautionary saving, and, possibly, demographic
developments. Finally, we explore the degree to which the HEW ratio affects the household
saving ratio in the short and long run. Our prior is that it is likely to matter in the short run,
but less so over time as alternative forms of wealth become more fungible.
We model the evolution of the saving rate in an error-correction framework, where in the
long run the saving rate is cointegrated with the net worth ratio and, potentially, real interest
rate and inflation. In the short run, the saving rate changes in response to its deviation from
the long-run equilibrium (the error-correction term) and, potentially, other variables. As we
are interested in the impact of home equity withdrawal on the saving rate, we will include it,
as a percentage of household disposable income, both in the long-run and in the short-run
relationships.
Our general specification takes the form:
()
1111 1thttntrttthtt
shewsnwr thew
π
α
αγβββπββ ε
−−−− −
∆= + ∆ − − − − − − +, (1)
where s is household saving, hew is home equity withdrawal, nw is household net worth
(financial and residential assets net of liabilities), all measured as a ratio to disposable
income), r is the short-term real interest rate, π is CPI inflation, and t stands for the time
trend.
16
Statistical tests indicate that these variables have a unit root in level, but are
stationary in first differences, and that they are bound by a cointegrating relationship.
Changes in cyclical variables, such as real GDP and the unemployment rate, were initially
added to the dynamic equation but were consistently not significant. Annual data were used,
with the estimation period being dictated by the availability of housing wealth data.
As can be seen from Table 1, in the long run the U.S. personal saving rate tends to decline
when household net worth rises relative to disposable income,
17
with a coefficient slightly
greater than two cents on the dollar,
18
and rises with increases in the real interest rate and
inflation. In addition, for given values of the explanatory variables, the saving rate trends
down over time, probably indicating a reduction in precautionary saving as liquidity
constraints were relaxed due to gradual financial liberalization. Home equity withdrawal was
not found statistically significant in the long-run relationship, so equation (1) was re-
estimated without that term. A ten percentage point increase in the ratio of HEW to
disposable income is associated with a temporary 1½–2 percentage point decline in the
saving rate, although the coefficient was different from zero at only the 12 percent
16
See Appendix II for variable definitions and data sources.
17
When entered separately, net housing wealth (value of real estate net of debt secured on dwelling) and net
financial wealth (financial assets net of nonsecured debt) had similar quantitative impact on saving.
18
This coefficient is somewhat smaller than values reported in other studies (e.g., Maki and Palumbo, 2001).
16
probability level. An increase in household net worth explains 1¾ percentage points of a
6 percentage point decline in the personal saving rate since 1993, while the contribution of an
increase in HEW is about ¼ percentage points. At the same time, an increase in HEW also
explains ¼ percentage points of a 2¾ percentage point decline in the saving rate between
2000 and 2005, when household net worth ratio did not change from the beginning to the end
of the period.
Table 1. United States: Time–Series Regression Results for Household Saving 1
/
Coefficient Standard error Coefficient Standard error
Long-run relationship
Net worth -0.02 (0.004) *** -0.02 (0.005) ***
Real interest rate 0.38 (0.08) *** 0.39 (0.08) ***
Inflation rate 0.39 (0.07) *** 0.39 (0.07) ***
Trend -0.13 (0.02) *** -0.14 (0.01) ***
HEW -0.11 (0.09)
Error-correction term 0.85 (0.16) *** 0.83 (0.16) ***
∆(HEW)
-0.18 (0.11) -0.16 (0.11)
Source: IMF staff calculations.
1/ Dependent variable is the difference in the saving rate. The estimation uses annual data for
the 1963–2005 period. Standard errors are in parentheses. *,**, and *** indicate significance at
the 10 percent, 5 percent, and 1 percent levels, respectively.
HEW in Long and Short Run HEW in Short Run Only
Results for the other countries (reported in Tables 2–4) confirm a negative relationship
between the saving rate and household net worth, with coefficients of the same order as in
the United States.
19
Real interest rate and inflation were positively correlated with the saving
rate in Canada, but in the relatively short time series for Australia and the United Kingdom
the relationship was not found statistically significant. The coefficient on the time trend was
not found to be significant in any of these countries, which is perhaps not surprising given
the short samples for Australia and the United Kingdom, and the limited evidence of
financial innovation in Canada.
19
The coefficient was not statistically significant in U.K. regressions.
17
Table 2. Canada: Time–Series Regression Results for Household Saving 1/
Coefficient Standard error Coefficient Standard error
Long-run relationship
Net worth -0.03 (0.02) * -0.06 (0.02) ***
Real interest rate 0.78 (0.18) *** 0.67 (0.25) **
Inflation rate 1.21 (0.21) *** 1.15 (0.28) ***
HEW 1.02 (0.46) **
Error-correction term 0.40 (0.10) *** 0.30 (0.09) ***
∆(HEW)
-0.03 (0.22) -0.21 (0.21)
Source: IMF staff calculations.
1/ Dependent variable is the difference in the saving rate. The estimation uses annual data for
the 1968–2005 period. Standard errors are in parentheses. *,**, and *** indicate significance at
the 10 percent, 5 percent, and 1 percent levels, respectively.
HEW in Long and Short Run HEW in Short Run Only
Table 3. Australia: Time–Series Regression Results for Household Saving 1
/
Coefficient Standard error Coefficient Standard error
Long-run relationship
Net worth -0.05 (0.03) * -0.07 (0.01) ***
HEW -0.44 (0.53)
Error-correction term 0.38 (0.29) 0.38 (0.29)
∆(HEW)
-0.20 (0.18) -0.15 (0.18)
Source: IMF staff calculations.
1/ Dependent variable is the difference in the saving rate. The estimation uses annual data for
the 1979–2005 period. Standard errors are in parentheses. *,**, and *** indicate significance at
the 10 percent, 5 percent, and 1 percent levels, respectively.
HEW in Long and Short Run HEW in Short Run Only
Table 4. United Kingdom: Time–Series Regression Results for Household Saving 1
/
Coefficient Standard error Coefficient Standard error
Long-run relationship
Net worth -0.02 (0.03) -0.02 (0.04)
HEW -0.18 (0.55)
Error-correction term 0.32 (0.37) 0.26 (0.30)
∆(HEW)
-0.51 (0.28) ** -0.47 (0.22) **
Source: IMF staff calculations.
1/ Dependent variable is the difference in the saving rate. The estimation uses annual data for
the 1989–2005 period. Standard errors are in parentheses. *,**, and *** indicate significance at
the 10 percent, 5 percent, and 1 percent levels, respectively.
HEW in Long and Short Run HEW in Short Run Only
18
The results with respect to home equity withdrawal varied across countries. In the United
Kingdom and Australia, HEW was not found significant in the long-run relationship. The
short-run coefficient in the Australian regression is of a similar magnitude to the U.S. result,
but is not significant, while in the United Kingdom the effect was close to a half, and
statistically significant. The effect of HEW on saving was also less temporary in these
regressions. Canada stands out as a special case, with an improbably large and positive
coefficient in the long-run relationship and a small, statistically insignificant short-term
coefficient. Given the small scale and limited fluctuations in HEW over time, we regard this
result as most likely reflecting spurious correlations.
We ran a panel regression (Table 5), although in view of cross-country heterogeneity this
exercise is mostly intended as an illustration and the summary of the data. The results support
the conclusion that HEW matters for saving in the short run with an effect of around 20 cents
on the dollar, but not in the long run. The negative long-run coefficient on net worth equals
approximately three cents per dollar. The long-run coefficient on the nominal interest rate is
about 0.9 (an increase in the nominal rate of one percentage point raises the saving rate in the
long run by 0.9 percentage points).
20
Table 5. Panel Regression Results for Household Saving 1/
Coefficient Standard error Coefficient Standard error
Long-run relationship
Net worth -0.03 (0.02) * -0.03 (0.02) *
Nominal interest rate 0.81 (0.32) ** 0.87 (0.36) **
HEW -0.36 (0.37)
Error-correction term 0.13 (0.05) *** 0.11 (0.05) **
∆(HEW)
-0.20 (0.09) ** -0.18 (0.09) **
Source: IMF staff calculations.
1/ Dependent variable is the difference in the saving rate. The estimation is on an unbalanced panel
of annual data with 132 observations and country fixed effects. Standard errors are in parentheses.
*,**, and *** indicate significance at the 10 percent, 5 percent, and 1 percent level, respectively.
HEW in Long and Short Run HEW in Short Run Only
VII. R
ECENT EXPERIENCE OF HEW IN AUSTRALIA AND UNITED KINGDOM:
IMPLICATIONS FOR UNITED STATES?
Given the concerns about the impact of the incipient slowdown in the growth rate of U.S.
housing prices, it is instructive to examine the experiences of the countries that have recently
gone through such a slowdown, namely Australia and the United Kingdom.
20
Results are similar if the inflation rate is entered instead of the nominal interest rate. The real interest rate has
not been found statistically significant in the panel regression.
19
In all three countries, the link between real
house prices and consumption appears to
have weakened dramatically since 2000 (see
Figure 8).
While there was some decline in HEW
around the time of house price deceleration
in Australia and United Kingdom, quarterly
data suggest that the rebound in the saving
rate was relatively small (Figure 9).
21
This is
broadly consistent with our regression results
that imply changes in HEW have a limited,
short-term effect on saving.
Figure 9. Australia and United Kingdom: House Prices and Home Equity Withdrawal
-5
0
5
10
15
20
1996 1998 2000 2002 2004
-5
0
5
10
15
20
Real house price
(y/y percent
change)
Home equity
withdrawal
3-month
interest rate
(percent)
Saving rate
(percent of disposable
personal income)
Sources: Haver Analytics; National Sources; and IMF staff calculations.
Australia
United Kingdom
-5
0
5
10
15
20
25
1996 1998 2000 2002 2004
-5
0
5
10
15
20
25
Real house price
(y/y percent
change)
Home equity withdrawal
3-month interest rate (percent)
Saving rate
(percent of disposable
personal income)
VIII. C
ONCLUSIONS
The regression results reported here are consistent with earlier studies in finding that U.S.
households react to an increase in their net worth and lower real interest rates by reducing
their saving rate. HEW also has a negative impact on household saving in the short run,
although its size is limited. This result indicates that the likely slowdown in U.S. house price
growth, HEW, and tightening financial conditions will lead to a recovery in the U.S. saving
rate. However, this rise is likely to be limited—for example, even a reduction in the HEW
ratio from the current 9 percent to its long-run average of 1 percent in a year would
temporarily boost the saving rate by about 1¼ percentage points, broadly consistent with the
recent experience of Australia and the United Kingdom. That said, a decline in the growth of
21
The HEW series used here are gross rather than net.
Figure 8. House Price Increases and
Consumption Growth 1/
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
1980 1985 1990 1995 2000 2005
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
A
ustralia
United Kingdom
Canada
United States
Sources: Haver Analytics; CEIC; National Sources; and IMF
staff calculations.
1/ Ten-year rolling correlation between growth of real house
price index (deflated by personal consumption deflator) and
growth in private consumption.
20
HELs and cash-out refinancing may have at least as large an impact, and possibly a more
persistent one, on housing investment through its effect on home improvement spending.
The inclusion of a trend variable, intended to represent the effects of financial liberalization
and innovation, is strongly significant in the U.S. regression results (although not elsewhere).
This is consistent with evidence that financial innovation lowers household saving by
increasing access to financial products. Another implication of this trend is that households
could be able to smooth consumption more effectively, lowering its volatility.
21 APPENDIX I
I. FINANCIAL LIBERALIZATION AND MORTGAGE PRODUCT INNOVATION
A. Selected Measures of Financial Liberalization
Australia Interest rate ceilings (1980) and other controls (1984) on bank deposits
abolished. Limits on savings bank assets abolished (1982).
Entry of new banks permitted, including foreign banks; abolition of exchange
controls (1983)
Securitization introduced (1987)
Canada Ceiling on bank loan interest rate abolished (1967)
Restrictions on bank mortgage financing abolished (1967)
Bank mortgage subsidiaries permitted (1980)
Securitization introduced (1987)
United
Kingdom
Abolition of capital controls (1979), money supply and credit controls (1980) and
minimum lending rate (1981)
Banks allowed to compete with building societies (1981)
Building societies allowed to diversify assets and funding sources (1986)
Securitization introduced (1987)
Second Banking Directive implemented (1993)
First issue of covered bonds (2003)
United
States
Securitization introduced (1971)
Phasing out deposit interest rate cap (Regulation Q – 1980 on)
Elimination of thrift portfolio restrictions (1980)
Sources: Boone et al. (2001); and Commonwealth Treasury of Australia.
B. Recent Mortgage Product Innovations
Australia Flexible mortgages with variable repayments;
Split-purpose loans (for primary and tax advantaged buy-to-let loans);
Deposit bonds (insurance company guarantees payment of deposit at settlement);
Nonconforming loans;
Redraw facilities and offset accounts;
New providers including mortgage originators and brokers.
Canada Shorter-term mortgages, initial fixed-rate period shortened from five years to one year,
more variable rate loans;
Skip-a-payment, early mortgage renewal and flexible payment schedules.
Easier access to subprime loans.
United
Kingdom
Flexible mortgages;
Offset mortgages (savings and mortgage held in same/linked accounts, with savings
offset against mortgage balance);
Base rate trackers.
Lifetime mortgages-equity release for retired homeowners
United
States
Hybrid and Interest-only loans with variable rates;
Flexible mortgages with variable repayment options, including negative amortization.
Sources: Scanlon and Whitehead (2004); and OECD (2005).
22 APPENDIX II
II. DATA ISSUES
The personal saving rate in the U.S. National Income and Product Accounts (NIPA) is
measured as a ratio of personal saving to personal disposable income. Both saving and
income are net of consumption of fixed capital, which represents primarily the depreciation
of housing stock. The personal sector includes households and nonprofit institutions serving
households (NPISH). Separate accounts for the two subsectors are available for only a
limited period for the United States and are not available for the other countries in this study.
It should also be noted that households enter not only as consumers and providers of factors
of production, but also as producers (“unincorporated businesses”—for example, family
farms). While we are in principle interested only in the former role of the households,
statistically separation between the two is infeasible, as, for example, the same assets may be
used both for personal and business purposes.
The calculation of personal saving in the four countries in this study is fairly similar. The
only exception is the United Kingdom, which focuses on gross rather than net saving. There
are more differences in the definition of disposable income. In particular, while interest
payments by households are subtracted before disposable income is calculated in Australia
and the United Kingdom, so that personal saving equals personal disposable income minus
personal consumption, in the United States and Canada some interest payments and some
transfers are considered to be made out of disposable income. There are also some
idiosyncrasies in the treatment of pension funds. Calculating saving rates on a uniform basis
for the four countries would be quite a complicated enterprise, and would likely result in
rather small and stable corrections. We have opted to use the national measures, which also
have the advantage of being recognizable, except for the United Kingdom, where we subtract
consumption of fixed capital from both saving and disposable income to arrive at the net
ratio, comparable to that of the other three countries.
Home equity withdrawal is calculated as the difference between borrowing secured on
dwelling and net acquisition of residential assets, both from the flow of funds. For Australia
and the United Kingdom, residential investment (from national accounts) net of consumption
of fixed capital is used as the subtrahend, since the flow of funds accounts cover only
financial flows. For Australia, borrowing secured on dwelling was calculated from a scaled
up series on the stock of housing debt for the household sector provided by the Reserve Bank
of Australia.
Our measure of HEW for the United States is close to a widely cited estimate by Greenspan
and Kennedy (2005), but is not identical due to differences in definition (in particular,
Greenspan and Kennedy focus on discretionary equity withdrawal) and coverage. The Bank
of England publishes regularly a measure of home equity withdrawal (Bank of England,
2006), and the Reserve Bank of Australia has shown its estimates on several occasions
(Reserve Bank of Australia, 2003, 2005). The evolution of their measures over time is very
close to that of our measures, but the level is lower largely because they arrive at their
23 APPENDIX II
measures by subtracting gross rather than net housing investment from borrowing secured on
housing.
Household net worth is calculated as a sum of the value of residential real estate and financial
assets minus liabilities, from national balance sheets. The inflation rate is the year-on-year
growth rate of the consumer price index, and the real interest rate is calculated as the nominal
interest rate minus inflation. For the United States and Canada, the interest rate is the yield on
a three-month treasury bill; for Australia, it is the 90-day bank acceptance rate; and for the
United Kingdom, it is the 3-month London interbank offer rate (LIBOR).
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