ON SEPT. 13, I TESTIFIED IN THE U.S. SENATE on “The Housing Bubble and Its Implications for the U.S. Economy.” My statement outlined the basic causes of the current housing downswing, estimated the depth and duration of the downswing, and discussed the likely economic consequences of the falloff in housing market activity as well as the likely impacts of several secondary effects of the evolving housing cycle. My basic conclusions were as follows:
Reasons for recession. Both the housing boom of 2004–2005 and the current housing contraction have unique features that make them substantially different from previous housing market swings. The big differences relate primarily to unusually stimulative financial market conditions during the boom, record-breaking increases in inflation-adjusted house prices, and an outsized presence of investors/speculators in single-family and condo markets.
The current contraction amounts to an inevitable mid-cycle adjustment, or transition, from unsustainable levels of home sales, housing production, and house-price appreciation to levels that are supportable by underlying market fundamentals.
What to expect. The previous boom involved more than two years of unsustainable housing market activity, and we're likely to experience a below-trend performance of home sales and housing starts of roughly similar duration. The down-swing in housing production should bottom out around the middle of next year before transitioning to a gradual recovery that will raise housing starts back up toward a sustainable trend by the latter part of 2008.
National average house-price appreciation is likely to be quite limited in the near term. Indeed, some decline is a distinct possibility, and the rate of price appreciation should remain below trend for some time. “True” house-price appreciation, accounting for upward bias in key price measures as well as price support from non-price sales incentives provided by sellers, will be even weaker.
The downswing in home sales and housing production will continue to detract from overall economic growth through mid-2007. However, much of this negative impact should be offset by strengthening activity in other sectors of the U.S. economy, keeping GDP growth reasonably close to a sustainable trend-like performance.
There are bound to be some adverse secondary effects of the recent housing boom and the subsequent downswing on the ongoing economic expansion. These effects include negative impacts on consumer spending from a fading wealth effect as house prices adjust as well as from the impacts of “payment shock” on homeowners facing upward adjustments to monthly payments on “exotic” types of adjustable-rate mortgages (ARMs) originated in 2003. However, the size and timing of these effects are not likely to seriously threaten the economic expansion.
Looking forward. The housing and economic outlook rests on a number of key conditions, and downside risks to the outlook are considerable. These risks include the possibility of spikes in interest rates or energy prices as well as large resales of homes back onto the markets by investors/speculators.
A deeper-than expected housing downswing should be countered by shifts in economic policy, particularly monetary stimulus by the Federal Reserve.
Chief Economist, NAHB Washington, D.C.