THE ECONOMIC EXPANSION THAT BEGAN IN LATE 2001 is still proceeding at a solid pace, and the housing sector is still one of the brightest stars in the economic sky. But housing is more and more being viewed as a threat to the economy, a proposition that holds little water.
THE CHARGES The tremendous performance of the housing industry, during both the recession of 2001 and the economic expansion since, has led to widespread charges that the sector is seriously overheated and will soon undermine the health of the entire economy. The threat supposedly comes from inflated house prices that are about to turn the housing market into another NASDAQ-type debacle.
Historically low long-term interest rates commonly are fingered as a key villain in this scenario, refusing to move up despite the strength of the economic growth and an extended process of monetary tightening by the Federal Reserve. We also hear about voracious speculators seeking quick capital gains, an unprincipled financial system that's doling out “exotic” adjustable-rate mortgages (ARMs) to home buyers, and a weak-kneed Fed that won't move strongly against what The Economist recently dubbed the biggest asset price bubble in history!
THE DEFENSES These charges are way off target. NAHB research shows that speculation in the new-home market is quite limited and that highly aggressive ARMs generally are not financing sales of new homes to owner-occupants. Also, the Fed should not use general monetary policy tools to manage asset prices, particularly those that vary considerably across regional markets.
To be sure, the fall of long-term rates has been an unprecedented tonic for housing during the Fed's campaign of monetary tightening since mid-2004. But Alan Greenspan is now trying to explain the behavior of long rates rather than declaring it a conundrum that can't be figured out. Indeed, a dramatically flattening yield curve (short rates up, long rates down) is increasingly being viewed as a phenomenon that can be lived with rather than as the traditional precursor of stagflation or recession. The ever-more-integrated global economy seems to be the key to this new world, and there's little desire to move backward to an economic and financial system that labors under the old rules.
THE VERDICT It's most likely that overheated local housing markets will cool down naturally as the entire interest rate structure gravitates upward, as previous house price surges erode affordability conditions, and as building continues in supply-constrained areas; this process already is under way in some high-priced markets. It's also likely that housing will pass the engine-of-growth baton to other sectors of the economy as the expansion rolls along. Given the housing industry's unprecedented run, this process is likely to occur sooner rather than later.
The economy should continue to move forward agreeably as various sectors rotate responsibilities, and the Fed will be there to shepherd this process. The NAHB projects healthy growth in economic output, employment, and household income, with well-contained inflation, and the housing sector will continue to perform quite well in that environment.
Chief Economist, NAHB Washington, D.C.