Housing, housing and more housing - that has been the dominant economic story for the last few weeks. The news has been universally bad: inventories are rising to 10-year high levels, buyers are already saddled with massive amounts of debt, homebuilders are cutting profit projections and overall investment is negative. And here is more from Nouriel Roubini:
housing is already in free fall and will cause a recession by the summer of 2007.
Here are his
three main arguments:
The direct effect of the fall in residential investment in aggregate demand will be as high as the effects of the fall in real investment in the 2000-2001episode. Then, real investment fell by about 2% of GDP. This time around the fall in residential investment alone - let alone the role other components of real investment, such as software and equipment, that are already falling in Q2 - will be as large as residential investment could fall from the peak of about 6.2% of GDP (the highest level since the 1950s) to as low as 4% of GDP at the bottom in 2007.
Here Roubini is talking about total US GDP and the effects of housing on that specific macro-economic number. According to the Bureau of Economic Analysis, housing was responsible for between 4-4.7% of US GDP during the later part of the 1990s expansion. Starting in the second quarter of 2005, housing was responsible for over 6% of US GDP. While a 1% difference may not seem like much, it's important to remember current US GDP is roughly $13 trillion dollars, making 1% equal to 130 billion dollars. In other words, housing is responsible for a lot of money. In addition,
The wealth effect of the tech bust was limited to the elite of folks who had stocks in the NASDAQ. The wealth effect of now falling housing prices - yes median prices are starting to fall at the national level - affects every home-owning household: the value of residential real estate has also increased to 48.5% of household wealth in 2006 from from 38.7% in 1996. Also, the link between housing wealth rising, increased home equity withdrawal (HEW) and consumption of durable and non durables is very significant (see RGE's Christian Menegatti brief on this), much more than the effect of the tech bubbles of the 1990s. Last year, out of the $800 billion of HEW at least $150 or possibly $200 billion was spent on consumption and another good $100 billion plus went into residential investment (i.e. house capital improvements/expansions). It is enough for house price to flatten - as they already did recently - let alone start falling - as they are doing now since they are beginning to fall in major markets - for the wealth effect to disappear, the HEW dribble to low levels and for consumption to sharply fall. Note that this year there will be large increases in the borrowing costs for $1 trillion of ARM's while this figure for 2007 will be $1.8 trillion. Thus, debt servicing costs for millions of homeowners will sharply increase this year and next.
The "wealth effect" is an economists way of saying that when home prices appreciate people are more inclined to spend because they feel richer. To explain why home price appreciation has been vitally important to this expansion, let's tie together a few facts. In 2000, the savings rate was 2%, meaning people were already spending everything they made on a quarterly basis before this expansion started. Second, inflation-adjusted non-supervisory wages have dropped for the duration of this expansion, even after the economy hit the 5% "full employment" level in December 2005. Over the same period of time, consumer spending has increased 18% after adjusting for the consumer-price GDP deflator. In other words, people don't feel richer because of increasing paychecks. Instead, they feel richer because of home price appreciation. As people see their home prices stagnate or drop in value, they are more likely to decrease their spending. When higher energy prices are added to the mix, a consumer spending slowdown seems far more likely.
The employment effects of housing are serious; up to 30% of the employment growth in the last three years was due directly and indirectly to housing. The direct effects are job lost in construction, building materials, real estate brokers and sales agents, and employees of the mortgage finance industry. The indirect effects imply that the role of housing is even larger than 30%. The housing boom led to a boom in consumer durables spending on home appliances and furniture. Indeed, in Q2 real consumption of such goods was already negative: as you have less new home built and purchased and less old homes refurbished and expanded, you get less purchases of home appliances and furniture. There are also other indirect effects of the housing bust on employment, even on the purchases of motor vehicles. Indeed, the current auto sector slump is not unrelated to the housing slump. As the Financial Times put recently, the sharp fall in the sales of Ford's pick-up trucks is related to the housing slump as such truck are widely purchased by real estate contractors. And indeed in Q2 real consumer durables (that include both cars, home appliances and furniture all related to housing) already fell, consistent with the view that we have now have a glut in the stock of consumer durables (durables consumption has a investment-like nature to it as such goods last for a long time). Thus, as housing sector slumps, the job and income and wage losses in housing will percolate throughout the economy.
This expansion's employment growth has been the weakest of any recovery since 1960. And employment growth has slowed down for the first six months of 2006. The economy has created 135,883 jobs per month since January - roughly 14,000 less then the economy needs to create to absorb the growing population. Employment growth has slowed greatly over the last three months, creating only 237,000 total jobs or 79,000/month. The chart below is for construction employment. Notice how it has stagnated for the entire year:
While construction employment does not tell the entire picture for the slowdown in establishment job growth, it is an important factor. As housing slows further, expect to see a decline in financial and professional services as well.
So, we have declining residential investment hurting overall GDP growth, slowing consumer spending and decreasing the number of jobs created. If Roubini is right, we've got some serious problems ahead.
If Roubini's predictions turn out to be true, it is imperative for Democrats to get in front of the issue NOW. They must start talking with a unified voice about how the Republicans have mismanaged the economy. And the Democrats must say it over and over again.
Update [2006-8-27 10:9:20 by bonddad]:: The following is from Canada's Globe and Mail. It echos Roubini's basic thesis:
Mounting evidence of a slowdown in the U.S. housing market has led some forecasters to increase the chances that the world's largest economy will be limping into a recession next year.
"We have decided to raise the odds of a U.S. hard landing to 40 per cent from 25 per cent," National Bank Financial economists Clément Gignac and Stéfane Marion said in a note yesterday.
One impact of the housing slowdown is that job creation in the construction industry -- which has been soaring in recent years -- has gone into reverse, he said.
An end to the housing boom will pressure home prices, leaving Americans feeling poorer and curbing consumer spending. "Until a few months ago, home prices were rising and people felt as if they were worth more and assumed that they were okay spending money," Mr. Banerji said.
"In light of the swift buildup of the inventory of unsold homes, it is only a matter of time before prices decline at the national level," Mr. Gignac and Mr. Marion said. A "deterioration of household net worth, at a time when the sum of the household energy bill and financial obligations has risen to a record share of disposable income, will force consumers to rebuild their savings rate."