By John W. Schoen Senior Producer
msnbc.com
updated 10/27/2006 1:15:41 PM ET 2006-10-27T17:15:41

One of the many benefits of the now-cooling housing boom — both to consumers and the U.S. economy — was the huge pile of cash extracted in the form of home equity loans and “cash-out” mortgage refinancings. But with home prices flattening, and that multibillion-dollar piggy bank drying up, can consumers continue the shopping spree that accounts for more than two-thirds of the U.S. economy?

Major Market Indices

So far, consumer spending and confidence seem to be holding up. But the slump in home prices — and the break in what had been a relentless rise in homeowners' equity value — has some analysts voicing concerns that the end of the housing boom could also spell the end of the extended consumer shopping spree that has been a mainstay of the U.S. economy. Retailers, many of whom have already locked in plans for the holiday shopping season, are keeping a close eye on the numbers.

Since 2000, when “irrational exuberance” finally sank the stock market, U.S. consumer and investors have turned to real estate for outsized returns. But unlike the paper profits they accumulated in the stock market — gains that went to Money Heaven when the market tanked — homeowners have been converting those rising home prices into cash.

“We have seen consumers use their homes as ATM machines,” said John Marcell Jr., a mortgage broker in Upland, Calif. “Whenever they get their credit card debt up high, they go ahead and refinance and bail themselves out. That’s well and good as long as you have a rising market. But when that rising market no longer rises, you have some real issues.”

The home-equity ATM machine in question is huge. At the end of last year, the total value of U.S. residential real estate stood at $21.5 trillion, according to Standard & Poor’s. That compares with $16.9 trillion held in U.S. stocks and $25.3 trillion held in fixed-income assets like bonds.

Homeowners have not been shy about tapping into that equity through refinancing — to the tune of more than $250 billion this year, according to the latest forecast from Freddie Mac, the government-chartered housing finance corporation. The same forecast sees cash-out refinancings falling sharply next year — to $152 billion — and again to $108 billion in 2008. By way of comparison, it took homeowners eight years to cash out $187 billion in home equity from the end of 1992 through 2000.

Just as the rise in readily available home equity has begun leveling off, adjustable mortgage rates are also beginning to take their toll. Many of those adjustables have two-, three- or five-year fixed rates that are now expiring.

“There’s a payment shock that some of these people are just being devastated with,” said Marcell. “A payment that was $1,500 is now $2,500. And that’s the impact that we’re concerned with. A lot of these people were not told what could happen when the adjustment periods come about.”

The same rate shock is hitting consumers who took out home equity lines of credit — or HELOCs — to take advantage of the low rates brought about by the Fed’s aggressive rate cutting after the stock market’s collapse. Until June 2004, the prime rate to which these loans are usually pegged was at 4 percent. Now the prime rate is at 8.25 percent, meaning sharply higher interest rate charges for home equity borrowers. Some of those homeowners with now-pricey HELOCs are going back to refinance once again — folding their credit line into a new primary mortgage and tapping any remaining equity to keep a lid on monthly payments.

What does all this mean for the U.S. economy? The only honest answer is: No one knows. For now most economists point to continued job growth and relatively mild inflation as signs that the housing slowdown will not have much significant, harmful economic impact.

Michelle Meyer, an economist at Lehman Bros., says the drop in equity cash-outs bears watching -- and that the slowdown may knock a percentage point off the U.S. economy's 2006 growth rate. But she expects the housing slowdown to create a "very mild shock to the consumer" and sees spending holding up well for the rest of the year.

Some economists argue that the overall levels of cash pulled out of rising home equity is less important that what consumers do with the money. If you’re paying off credit card debts or re-investing in a new kitchen, the result is a lot like putting the money into savings. If you’re cashing out to pay for a trip to Hawaii, on the other hand, that source of vacation financing is not sustainable. 

Savings at the pump
Lower gas prices may take some of the sting out of the end of the housing boom. After peaking just over $3 a gallon in mid-July, gasoline prices have fallen sharply. In some parts of the country, pump prices have fallen back through the $2-a-gallon mark.

The savings to consumers have been sizable. American drivers save some $3.8 million a day for each penny in the drop of a gallon of gasoline, according to oil analyst Peter Beutel. That means consumers have saved more than $3 billion from falling pump prices in September alone.

And the most important single factor driving any consumer’s spending is, of course, whether that consumer has a job. The U.S. economy continues to add jobs — at the rate of more than 130,000 a month this year. For those who do have jobs, wages continue to hold up.

But the housing slowdown could create yet another drag on economy by chipping away at those strong levels of employment.

“Approximately two out of five jobs created from 2001 to 2005 were directly related to housing construction, real estate sales, leasing or mortgage finance,”  according to Frank Nothaft, chief economist at Freddie Mac.

Give the rapid run-up in the past two years, a housing slowdown was inevitable. So far, price declines have been relatively tame. And despite the recent rapid decline, it’s important to keep the current level of home sales in perspective. If current trends continue, 2006 will still be the third-best year for the housing market since in half a century, said Nothaft.

“When we were in 2003, everyone was happy with the housing market; everyone said, 'These are great times,'” he said. “Well, 2006 will probably come in stronger than 2003, yet everyone is worried about the drop in activity. It’s important to keep it in perspective. 2005 was off the charts.”

But it’s far from clear whether the downturn will remain mild — a so-called "soft landing" — or  pick up steam. Many analysts expect home sellers sit tight and ride out the slump, in which case prices may gradually bottom out by mid-2007. But some are cautioning that a steeper, more prolonged drop in prices is not out of the question.

“(The housing boom) is the biggest boom we’ve ever seen in this country,” Yale economist Robert Shiller told CNBC. “People forget that. It’s huge, and it may be coming to an end now. One scenario going forward is that it will be something like the stock market: that is, declining — maybe with up and and downs — for a period of years."

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Data: Latest rates in the US

Home equity rates View rates in your area
Home equity type Today +/- Chart
$30K HELOC FICO 4.40%
$30K home equity loan FICO 5.80%
$75K home equity loan FICO 4.54%
Credit card rates View more rates
Card type Today +/- Last Week
Low Interest Cards 13.70%
13.70%
Cash Back Cards 17.66%
17.91%
Rewards Cards 17.05%
17.17%
Source: Bankrate.com