The Christopher Columbus of central banks has discovered what everyone knows – Canadians are burning equity. A LOT of it. Bank of Canada (BoC) staff have concluded homeowners are extracting a lot of home equity. Consumption and the economy are boosted by the home equity extracted. However, the more significant the sum extracted, the more vulnerable the economy becomes to a housing correction.

The Collateral Effect

The withdrawal of home equity tells us a lot, but today we’re focusing on the collateral effect. This is when people extract home equity to spend, as home prices rise. What’s the point of being a multi-millionaire bungalow owner, if you can’t have a few toys – right? This spending helps to propel the economy. It’s a twofer – home prices rise and the economy gets a boost. Score!

BoC researchers warn, this is a problem if the collateral effect contributes meaningfully. If home prices fall, the equity-based spending disappears. Combine that with slower sales, which leads to lower spin-off economic activity. A decline in home prices is no longer just a hit to paper-based wealth. It has a significant impact on the general economy, and employment. Oxford Economists have been discussing the collateral effect’s role in the US and UK, since the Great Recession….CLICK for complete article