Debate Over Housing Market’s Impact On U.S. Economy Continues
After four years of robust growth, the U.S. economy has decelerated sharply — from 5.6 percent annualized growth in the GDP in the first quarter to a 2.2 percent pace during the third quarter. There is considerable debate over the pace and direction of growth in 2007.
Until recently, the consensus on Wall Street was that U.S. economic growth would be roughly in line with the trend rate (approximately 3.2 percent) in 2007. However, sentiment has now shifted, sparked by a debate surrounding three macroeconomic factors:
- The housing market decline
- The direction of monetary policy
- The sustainability of the current account deficit, and the effect of a depreciating dollar
The United States has experienced real GDP growth averaging 3.2 percent a year for the past three years, and growth was a respectable 3.0 percent in the four quarters ending with the third quarter of 2006. U.S. households have proven to be resilient spenders, even in the face of energy prices, hurricanes, the war in Iraq, and wide swings in consumer confidence.
However, growth has slowed in 2006. GDP growth was 5.6 percent in the first quarter, followed by 2.6 percent in the second quarter and 2.2 percent in the third quarter. There has been particularly steep erosion of spending. This deceleration in growth has led some forecasters to revise their projections downward for 2007.
The direction of the U.S. economy in 2007 will be heavily influenced by the housing market. Although housing only accounts for about 5 percent of GDP, it has been responsible for up to 75 percent of all job growth in the past four years. Employment has surged in residential construction, and a sharp increase in mortgage lenders and real estate appraisers.
During boom phases, U.S. housing starts tend to peak at about 2.0-2.2 million starts, and by 2005 and early 2006 housing starts were at this level. An analysis of the five major U.S. housing market corrections since 1970 shows that when the market turns down, it tends to fall roughly in half — to about 1 million starts. On average these five U.S. housing down cycles lasted about 18 months.
With starts having fallen for about nine months and with starts down to about 1.5 million units, some home builders say the downturn is about over. However, history suggests that the housing downturn will continue.
Shortly before he left office in January, former Federal Reserve Chairman Alan Greenspan prepared a research paper that quantified the effects of home mortgage equity withdrawal on household finances.
Greenspan estimated that “cash out refi” boom had boosted consumer spending by roughly $300 billion a year from 2001-2005. The thrust of his research suggested that if housing prices would flatten off or fall, this engine of growth could disappear.
Current Fed Chairman Ben Bernanke has been asked repeatedly if he shares his predecessor’s concern about the possible negative impact of a housing slowdown on consumer spending, but has indicated that he does not have any special concerns.
However, there is evidence that the widespread home equity loan withdrawal among consumers is declining rapidly. By some estimates it has fallen at an annual pace of at least $100 billion — and perhaps at a $200 billion pace since the end of Q3.
The Fed’s public statements still stress its concerns about inflation, and several voting board members have indicated that they believe additional tightening is needed. However, this is at odds with futures markets, which see a better than 50 percent chance of a rate cut by March 2007.
In effect, the markets are indicating that the worst of the inflation problem is over, and that the housing slowdown will start to cool consumption.