The U.S. economy is searching for the next “virtuous cycle,” a state of self-sustaining growth where one element of the economy — say, jobs — feeds another, such as consumer spending, which prompts businesses to produce more goods and services, which comes back around to spur job growth.
The virtuous cycles that brought the U.S. out of previous economic downturns all started with housing. In 1982, 1991 and 2001, lower mortgage rates brought on by recession led to increased housing demand and spurred new home construction and remodeling. This accelerated consumer spending on durable goods like refrigerators and TVs. That fueled job creation and then — you guessed it — economic growth, which spurred more home sales and consumer spending.
In the past two years, however, housing prices have kept falling even as the rest of the economy began working its way back from the 2008 recession. And they still may not have hit bottom nationally. Homeowners lost $7.3 trillion in home-equity wealth due to falling home prices since their peak in 2006, according to data from the Federal Reserve. As many as 4 million homes could enter foreclosure during the next two years, depressing prices even further.
This creates an opposite effect, called a “vicious cycle.” It hits housing-related industries, such as home furnishings, rentals and utilities, which together make up about one-fifth of the gross domestic product. And because home ownership makes up a significant amount of household wealth, house price declines affect many other consumer economic decisions, such as automobile and food purchases, recreation and holiday shopping. Down goes consumer spending, which makes up 70 percent of GDP.
The challenge for the next president will be to address the fact that U.S. economic growth once again depends on a sustained housing recovery.
Three housing-market headwinds are feeding the vicious cycle and working against economic growth. First are falling home prices, which drive down household wealth. According to the latest Survey of Consumer Finances, median net wealth declined by 38.8 percent from 2007 to 2010. The decline was greatest for families for whom housing was a large part of their assets. In 2005 housing wealth was 50 percent of net worth for U.S. households; in 2011, housing wealth comprised just 38 percent.
Economists Karl Case and Robert Shiller, creators of the house price index, estimate that homeowners reduce consumption spending by $3 to $5 per year for each $100 in housing wealth lost. They say a 30 percent decline in housing wealth from 2005 to 2009 reduced U.S. household consumption by $240 billion a year. Meanwhile, they found only a weak link between stock market wealth declines and household consumption spending.
The second headwind is increased inventory. While the 2.5 million homes available in the first quarter of 2012 is down from 3.2 million units available a year earlier, there remains a “shadow inventory” of an estimated 4 million units not yet on the market but likely to get there because they’re seriously delinquent or in foreclosure.
What’s more, a quarter of mortgage holders owe more on their mortgages than the houses are worth. This negative equity makes it harder for homeowners to sell their homes and move to where there are better job opportunities. Labor mobility, and, by extension, economic growth is held back.
The third negative force is the mortgage lending market, which remains stalled despite the fact that housing affordability is at an all-time high and mortgage rates are very low. Banks are more cautious in their lending, which is also to blame for sluggish housing sales. Mortgage lending rose steadily in the late-1990s, peaking at $1.2 trillion in the first quarter of 2006 before falling drastically. For all but one of the past 15 quarters through the fourth quarter of 2011, net mortgage lending has been negative, meaning that households are paying back more on their mortgages than new lending is being issued.
Since the financial crisis, the government has subsidized almost all mortgages directly through the Federal Housing Agency and its financing arm, Ginnie Mae (FGMNX), and indirectly through government-sponsored enterprises Freddie Mac and Fannie Mae. By playing such a large part of the housing market, it stands to reason the federal government must play a key role in reigniting housing activity.
The next administration has two choices: Lead the transition to a virtuous cycle of economic growth by focusing more aggressively on housing, or continue to subsidize the housing market with taxpayer dollars. In any event, only a rebound in housing will cure this home-sick economy.
(Nela Richardson is an economic analyst with Bloomberg Government. The views expressed are her own.)
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