North Worries About South Turn

The Canadian newspaper The Globe and Mail published a story today regarding a new report released by Toronto-Dominion Bank that claims it won't take a total collapse of the U.S. housing bubble to stop economic growth. The report contends that even if there is no dramatic "pop," all it will take for this tragic event is a return to normal, pre-bubble house price growth. Other analysts have made similar observations. The problem is that U.S. economic expansion has been driven in large part during the past few years by real estate-based consumer wealth.





From The Globe and Mail:

This has created an unprecedented "wealth effect," which (TD economist Beata Caranci ) defines as the amount of money someone will spend in response to a sustained and often unexpected change in their wealth.

"In the U.S., the resulting wealth effect from a rapid appreciation of real estate assets and the greater ability to directly tap into housing wealth through home equity lines of credit has been so great that it alone has accounted for, on average, half of the growth in real consumer spending over the past 2? years," she says.

"Likewise, as credit and housing demand eases against a backdrop of higher interest rates and record personal debt loads, a wilting wealth effect will be the catalyst of a mid-cycle slowdown that will see annual growth in U.S. economic activity ease to less than 3 per cent [annualized] in the second half of 2006." In short, it will not take a full-scale correction to do the damage.

Ms. Caranci notes that U.S. household debt is in "uncharted territory" at 121 per cent of after-tax incomes. This, she says, "introduces an entirely new element of risk that has yet to be tested."