In a new Economic Letter for the Federal Reserve Bank of San Francisco, University of California, Davis professor Paul Bergin takes a look at the relationship between rising housing values and increased debt.  And he sees a fairly strong one:

To what degree were households able to cash in on rising asset values by selling or borrowing off of those assets? Figure 3 (below) shows the components of the U.S. financial account, which tracks the sale of assets used to finance the current account deficit. The dramatic rise in total financial inflows in the mid-2000s was tracked almost fully by a rise in international net sales of debt securities, including government and private-issue securities. The other two main categories, direct foreign investment and international net sales of stock, did not rise in similar fashion to finance the rising current account deficit. In fact, net trade in those two categories was negative for most of those years. That indicates there was a net outflow of capital in those two categories. Thus, foreign direct investment and international sale of U.S. equities were not part of the capital inflow that financed the current account deficit.

This pattern reflects the tendency of U.S. investors to purchase higher-risk, higher-yield foreign assets, such as international stocks, while selling lower-risk, lower-yield assets such as debt securities to foreigners. The lower volume of net trade in stock and direct investment suggests that consumers were not able to cash in on rising asset values by directly selling assets in those categories abroad. Rather, it appears that households used their higher-value assets as collateral to gain access to the U.S. financial market and take out loans. Some of those loans made their way overseas in the form of net sales of debt securities.

It appears that the rise in U.S. stock and housing prices was in part to blame for the fall in national saving and the rise in the current account deficit. This may help explain why the collapse of the prices of those assets was so potent in reducing the U.S. current account deficit. It may be that the sharp fall of the housing and stock markets was the mechanism needed to reduce large current account imbalances not only in the United States, but in other countries that had taken advantage of rising asset prices to finance consumption. In this way, falling asset prices have brought current account deficits back to more sustainable levels and helped restore a better global financial balance.

Read Asset Price Booms and Current Account Deficits here.