TheMReport

January, 2013

TheMReport — News and strategies for the evolving mortgage marketplace.

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feature Or ig i nat ion SECONDARY MARKET The Wealth Effect se r v ic i ng Forecasts resulting from the Fed's recent Flow of Funds report hinge on perception becoming reality for today's consumers, with many projections betting big on borrowers' beliefs about the marketplace. s e c on da r y m a r k e t a na ly t ic s By Mark Lieberman M any positive indicators from the Federal Reserve's latest Flow of Funds report were readily apparent, since increases in net worth and home values are obviously good news in a struggling economy. However, the Fed's projections for a longerterm impact emerging from the trends observed were less tangible. Citing the influence of the "wealth effect," the Fed gambled on improving consumer sentiment with an optimistic forecast that hinged on Americans "feeling" more financially stable. Contemporary calculation of the "wealth effect" differentiates between the growth in the value of real estate and stock market assets, with the change in real estate values having a larger impact on spending. And for now, the Fed's findings support the idea that consumers will enter the "wealth effect" cycle, as the Flow of Funds demonstrated a $370 billion jump in the value of household real estate and expanding household net worth, which grew $1.7 trillion in the third quarter of 2012 to hit a total of $64.8 trillion. Additionally, the Fed touted the $390 billion increase in owners' equity stemming from the collision of rising values for owneroccupied household real estate 76 | The M Report and the $85.8 billion decline in total residential mortgage debt. According to the Fed, owners' equity as a percentage of the value of the real estate rose to 44.8 percent, the highest level since 2007. But while some of the Fed's figures confirm that the nation may be developing a buffer against income declines and other financial fluctuations influencing economic behavior due to the "wealth effect," a deeper look into current statistics shows that expectations could be premature. The Flow of Funds, which provides a comprehensive look at aggregate household and corporate balance sheets and income statements, is designed to serve as a sort of "blood pressure reading" on the economy and its components, and though some data displayed a healthy level of pressure, other numbers signaled a continuing crisis. Flagging findings included: •• Disposable Income Increases Stall: According to the report, the pace at which disposable household income is improving slowed during the quarter, rising 0.5 percent, or $61.1 billion. The reading fell short of the post-crisis quarterly average of 0.7 percent, and the drop represented a 0.2 percent decline from second-quarter increases, which kept pace with the current average at 0.7 percent. •• Spending and Slippage: The slippage in personal income growth signaled another challenge to an economy heavily dependent on personal consumption spending, which comprises more than 70 percent of the nation's gross domestic product. •• ebt Improvements Fall Flat: Total D household debt fell $10.9 billion in the third quarter of 2012, flat-lining with a decline of just 0.08 percent. How will the headwinds impact the recovery of housing and the broader economy short-term? The marketplace is preparing for a rocky start to 2013, but the remainder of the Fed's positive points herald likely growth later in the year. Other encouraging findings from the Flow of Funds survey included: •• Market Corrections: The improvement in household net worth more than reversed a $157.2 billion drop during 2012's second quarter, indicating that assets accelerated faster than debts. •• ssets Advance: Most of the A change in net worth observed within the Fed's report resulted from from asset growth attributable to the stock market; the value of stock holdings rose $524.4 billion in the third quarter, reversing the $386 billion drop seen during the second quarter of 2012. •• rends Display Endurance: The T drop in mortgage debt marked the 14th straight quarterly drop, and according to the Fed, aggregate mortgage debt at the end of the second quarter of 2012 was $9.489 trillion, the lowest level in more than six years. Though general analysis of the Fed's survey indicated that improvements in the mortgage and financial industries will advance, not everyone in the

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