Housing is the engine driving the US economy. According to a Merrill Lynch analysis, it is responsible for 50% of current US economic growth. So, what happens if housing starts to slow? Below are some of the possibilities for the economy.
Jobs: More than 40 percent of new private sector jobs added in the first several years of the current expansion were related to housing, although that percentage has fallen sharply as the broader job market has accelerated, according to Northern Trust research. Still, a sharp downturn in sales could mean layoffs for construction workers, real estate agents, mortgage brokers and even many employees at Wall Street firms that help provide the capital for new mortgages.
Since January 2001, the U.S. economy has created 2,093,000 establishment jobs. Of this number, 636,000 or 30% are construction jobs That's a big chunk. However, the economy has also created 315,000 professional and business services jobs and 489,000 financial services jobs. Professional and business services jobs would cover realtors, appraisers and engineers, architects etc... I have seen no estimate of the total amount of professional service jobs related to the housing industry. Given the huge increase in construction jobs related to total establishment jobs, a conservative estimate would be 20% or 63,000. If we make the same assumption with financial services (for mortgage banking services) we get 97,800. If we total all these jobs up we get 796,800 total jobs related to housing, which is 38% of the total number of establishment jobs created. (All data in this paragraph is from the Bureau of Labor Statistics).
Consumer spending: The run-up in housing has boosted consumer spending in two ways - through a psychological "wealth effect" and by allowing owners to turn their homes into giant cash machines, withdrawing equity at a record annual rate of more than $600 billion last year, compared with less than $200 billion a year in the late 1990s. If home prices flatten or turn down, there will be no more equity to withdraw, and consumers who have much of their wealth tied up in a single asset will no longer feel inclined to spend so freely.
Consumer spending represents 70% of US GDP growth. Therefore, consumers have to spend for the US economy to grow. However, the US consumer was already spending 98% of his monthly income in 2000 and currently spends more than he makes. In other words, the US consumer was already spending most of his earnings before this expansion started. Since January 2001, the consumer has increased his spending by a price deflater adjusted total of 18.35%. However, his earnings have barely increased. According to the Bureau of Labor Statistics, non-supervisory wages (which represent about 80% of US earnings) increased from $14.28 in January 2001 to $16.41 in January 2006 for an increased of 14.91%. Over the same time, the overall inflation index increased from 175.1 to 198.3, or an increase of 13.24%. Therefore, overall non-supervisory wages have increased 1.67% since January 2001. The recent Federal Reserve Report titled Recent Changes in US Family Finances confirms this trend. According to the study:
The survey shows that, over the 2001-04 period, the median value of real (inflation adjusted) family income continued to trend up, rising 1.6%, whereas the mean [average] value fell 2.3%. The results stand in contrasts to the strong and broad gains seen for the period between the 1998 and 2001 surveys and to the smaller but similarly broad gains between the 1995 and 1998 surveys.
So, the consumer who was already spending most of his income in 2000 (as evidenced by the 2% national savings rate) has increased his spending at an adjusted rate of 18.35%, but he his wages have increased 1.67%, his median income has risen 1.6% and the overall average income has dropped 2.3%. Where is the new money coming from?
Debt. Total mortgage debt outstanding has increased from 4.8 trillion in the first quarter of 2001 to 8.2 trillion in the third quarter of 2005 - an increase of 70%. Consumer debt loads have increased faster in the last 5 years than they did in the preceding 15 years.
If housing prices start to stagnate or decline, this method of acquiring money to finance consumer spending will dry up. This will slow the 70% of GDP growth that comes from consumer spending.
Problem loans: More than 40 percent of the dollar volume of new loans has been made with adjustable mortgage rates in recent years, compared with less than 20 percent in the early 1990s. As interest rates rise, many owners who stretched to buy a house will find themselves facing higher and possibly unaffordable payments. If housing prices turn down, some owners could find themselves "upside down" on their loans, owing more than the house is worth. A a true housing bust - comparable to the collapse that deflated tech-stock values in 2000 - holds the capacity to "cripple the banking system," Kasriel said. That would make it difficult for the Federal Reserve to revive flagging growth since banks would be hard pressed to loan money even if rates were falling.
According to a recent article in Barron's, 1 trillion (roughly 12.5% of outstanding mortgage loans) of the total outstanding loans are "sub-prime" - meaning they were made to people with less than stellar credit ratings. Over the next two-years 600 billion - a full 60% -- will reset or change the total interest rate charged on the loan. With the Fed raising rates, these resets may place sub-prime borrowers in a big squeeze: they will face stagnant wage growth and higher mortgage payments. As Merrill Lynch economist David Rosen noted, total household payments devoted to necessary expenditures has increased from 48% to 54% over the last 5 years (this number vacillated between 44% and 48% for the preceding 20 years). While no one is predicting economic Armageddon from this event, there is understandable cause for concern.
So, housing is responsible for about 40% of establishment job growth in the last 5 years. It has provided financing for consumer spending through mortgages and home equity refinancing. And, 7.5% of total outstanding mortgage debt is sub-prime that will reset at higher rates in the next 2 years. If housing slows, this economy could take a big and ugly hit.
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