There is housing, and then there’s the rest of the U.S. economy.
How can such a small sector of the $13.3 trillion economy exert such a strong downward pull on the whole thing? Real residential investment, as it’s formally known in the gross domestic product report, accounted for 2.4 percent of GDP in the third quarter. At its frothiest, in 2005, that share stood at 6.2 percent, a three-decade high.
The answers can be grouped into two categories: tangible and intangible.
The tangible constraints are simple: too many homes on the market, including foreclosed properties and short sales by banks, and too few potential buyers who can move or trade up. Unfortunately the housing inventory can’t be moved to accommodate job openings.
The intangibles include the loss of wealth from the housing bust. With home prices down about 30 percent nationwide from their peak, households feel poorer and spend less.
The Fed is trying offset this poverty effect with a second round of quantitative easing designed to improve financial conditions and lift stock prices, among other things. When asset prices rise, people feel wealthier, even though their gains are unrealized, and they spend more.
That’s what happened when home prices were scaling the heights in 2005, posting gains of 15 percent annually. And we all know how well that worked out -- at least for a while.
To date the wealth effect in stocks hasn’t been large enough to offset the potent poverty effect in real estate. Owners’ equity in household real estate, or the value of assets minus liabilities, fell from a peak of $13.1 trillion in 2005 to a low of $5.9 trillion in the first quarter of 2009, according to the Fed’s Flow of Funds report. That’s a whopping 55 percent decline in four years. By the second quarter of 2010, owners’ equity had climbed back to $7 trillion.
Even with the 87 percent rebound in the Wilshire 5000 Total Market Index from the March 2009 lows, household net worth is still below its 2007 peak.
Housing, which along with manufacturing has traditionally led the economy out of recession, won’t be pulling its weight this time -- even with historically low mortgage rates. And there isn’t anything the government can do except let prices fall so the market can clear, something it’s been unwilling to do.
Residential real estate has subtracted from GDP in 17 of the last 19 quarters. Recently the contribution has been less negative than it was in 2006, 2007 and 2008. Still, just when you think housing has hit bottom, it underperforms even low expectations.
The rest of the U.S. economy is actually starting to look better. By all accounts, the Christmas shopping season is off to a strong start. Consumers are spending, which is either good for retailers or bad for consumers who have too much debt and too few jobs. Friday’s employment report for November, with its statistically insignificant increase of 50,000 private sector jobs, failed to validate the improving trend in weekly jobless claims and the first sign of job creation from small businesses in more than 2 1/2 years.
Recent manufacturing surveys have been upbeat as well. Corporate profits set a record in the third quarter. And the Fed’s pump-priming is starting to spill over to broad money growth.
A number of commentators have suggested the Fed’s real target in creating higher inflation (or is it higher inflation expectations? I get confused.) is house prices. Almost one-quarter of all single-family homeowners owed more on their mortgage than their home was worth in the third quarter, according to Zillow.com, a real-estate information service.
Price of Success
Higher inflation would help underwater homeowners in two ways. By raising home prices, it would increase owners’ equity. At the same time, inflation would ease the mortgage burden because borrowers are paying interest and principal in dollars that are worth less.
It’s true that the Fed can create money out of nowhere. What it can’t do is direct how those dollars are allocated: to stocks, to junk bonds or to consumer goods and services. While memories are short, they’re acute enough to remember the wealth destruction from the collapsed housing bubble. A burst bubble is hard to re-inflate.
House prices would benefit from generalized inflation.
“I know of no case where a central bank that wished to boost inflation and/or nominal GDP was unable to do so,” writes Scott Sumner, professor of economics at Bentley University in Waltham, Massachusetts, on his blog, themoneyillusion.com.
Phew. For a minute I was worried. The antidote to the poverty effect won’t be applied to just homeowners. We’ll all get to share the wealth!
(Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own.)
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