Auto sales momentum has surged in recent months, with the seasonally adjusted annual rate of sales (SAAR) jumping to levels not seen in several years. While some sales strength undoubtedly stems from the recovery of sales not made last summer during the shortages created by the Japanese earthquake, a growing series of data points to the release of longer term pent-up demand, supported by a recovering economy. Support for auto sales comes from recent improvements in the U.S. economy, including growth in GDP and jobs and expanding access to credit, as well as a stronger stock market and rising consumer confidence. In addition, for the past couple months, some data on housing have suggested that that market finally might have hit bottom and could even be in the first stages of a recovery.
Unlike the other aspects of the recovery, though, the ability of a housing recovery to boost auto sales—at least in the near term — is likely to remain limited because of a lack of growth in housing wealth. Increases in housing wealth tend to result in increased consumption, including vehicle purchases. While the demand for housing appears to be growing, housing prices have not reversed in any significant way and are still declining in many areas.
Pre-Recession: A Match Made In Heaven
Housing wealth created by rising home prices can support auto sales in several ways. As documented in multiple economic studies, greater housing wealth leads to greater consumption, including consumption of durable goods such as autos. Homeowners fund their additional spending through capital gains, refinance cash outs, home equity lines of credit, and/or home equity loans. Consumption also may increase for the adult children of homeowners whose housing wealth grows due to intergenerational transfers. In some cases, parents with more housing wealth provide financial assistance so that their adult children can buy their own homes — and accrue their own housing wealth. In addition, increased housing wealth also generates higher consumer confidence — itself a key driver of auto sales.
Prior to the Great Recession, all of these effects enabled the booming housing market to contribute to strong auto sales, which hovered around 16 to 17 million units annually for nearly a decade. An unprecedented expansion of credit availability facilitated both housing and auto sales growth. A variety of new loan types that minimized down payment requirements and offered flexible terms allowed more consumers than ever to purchase homes and to obtain home equity lines and loans. Meanwhile, because more consumers were able to obtain financing, demand for housing grew and drove up housing prices. As a result, equity grew and so did borrowing against newly accrued equity — both of which increased consumption, including new vehicle purchases.
Post-Recession: Lost Housing Wealth Still Lost
During the housing bubble that preceded the Great Recession, the value of household real estate in the United States peaked at $22.7 trillion in 2006, according to the Federal Reserve Flow of Funds report. At that time, mortgage debt stood at approximately $10.5 trillion. Since then, the value of household real estate has fallen $6.75 trillion and was still falling at the end of 2011, when it stood at $15.96 trillion. In contrast, mortgage debt fell only $700 billion to $9.8 trillion in the fourth quarter of 2011. As a result of the decrease in housing values relative to mortgage debt, many homeowners owed more than their homes were worth. This situation persists today. Some 11.1 million homeowners — 22.8 percent of all mortgaged properties — were underwater in the fourth quarter of 2011. And, CoreLogic estimates that there is more than $715 billion of negative equity weighing on the housing markets.
One key problem contributing to the number of homes with negative equity is falling home prices, driven by a foreclosure pipeline that is pushing down national home values. Prices have yet to show significant signs of recovery — perhaps not surprisingly. According to economic research, housing prices take six years on average to bottom out after recessions triggered by financial crises. In some cases, housing prices do not reach their previous peak levels before the next business cycle trough.
Any recovery in housing to date has been centered around growth in home sales and housing starts. It is necessary for housing supply to decrease, and demand to increase, for the economy to fully recover, and progress on this front will contribute to auto sales growth through the general rise in economic conditions. But, without an increase in housing wealth — and the accompanying rise in consumer spending and confidence, the housing market will continue to constrain auto sales growth.
Lacey Plache is the Chief Economist for Edmunds.com. Follow @AutoEconomist on Twitter.