How Will the Housing Slump Affect the U.S. Economy?

The WSJ's Celia Chen: "Housing markets are sliding fast. Home sales are well off of last summer's peak, house prices are down on a year-ago basis, inventories are mounting, and leading indicators of housing activity suggest that the market will weaken further before it turns up. Indeed, by at least one indicator, conditions have sunk to the depths hit during the last housing bust in the early 1990s.

Housing markets clearly need to correct to offset some of the excesses that have built up during the exceptionally strong boom of the last several years. The bad news is that the correction will take about one half of one percentage point off of GDP growth this year and another three quarters of a percentage point off of growth next year, as the slowing in housing hurts employment, construction activity and reverses the wealth effect.

The good news is that the market is correcting, not crashing -- and other economic drivers are strong enough to withstand the hit."

Columbia University's Christopher Mayer writes:
"I generally agree with Celia. Yet a longer historical perspective is also necessary. The housing market is still in reasonable shape, even if housing indicators are below their recent historical highs. Existing home sales and housing starts are above their levels a decade earlier and more than 50% above their cyclical lows in the early 1990s.

The recent 0.50 percentage point decline in mortgage rates, falling construction costs and increasing commercial construction will likely ease the macro effects of a housing slowdown.

Despite the hype about adjustable rate mortgages, statistically, housing prices in the last three decades have been much more responsive to changes in long-term real rates than to inflation or short-term rates. Housing did not stop rising when the Fed started raising rates two years ago, but it did slow when long-term real rates started their sustained rise at the end of 2006. If long rates increase again, the housing market may be in for much more trouble.

Of course, there is no national housing market, and individual markets respond very differently to national trends. Newspapers and commentators have been calling this a bubble for more than four years.

The evidence just does not support this claim, as I noted last year in the Journal. However, some markets are clearly in trouble (South Florida, Phoenix, Las Vegas and, to a lesser extent, California). Condominiums are facing much more difficulty than single-family homes."

Celia Chen writes: Chris and Susan bring up great points. Real estate is definitely all about location, so while the nation will not suffer terribly from the downturn in housing, there are regions of the nation that will be more vulnerable.

The Northeast urban centers and the smaller metro areas on the perimeters of the Bay Area and Los Angeles come to mind as areas where prices are highly elevated, and where the local economic outlooks are somewhat weaker than average. As Chris mentioned, the condo market is even more overdone than the market for single-family homes, and this imbalance adds downside risks to places like Florida despite its strong economic fundamentals. While we are not expecting any of these areas to fall into a recession, the risks on the downside are high.

A housing slowdown will impact the local economies directly through weaker employment in housing-related industries. Indeed, these industries have grown quite a bit as a share of total employment through the housing boom.

Additionally, the wealth effect from gains in home equity will dissipate. Together, these two forces helped to add one percentage point to real output growth last year, and their unraveling will make times harder for homebuilders and retailers this year.

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