It may be too soon to declare the U.S. economy has entered a recession, but there is ample evidence that the downturn in the housing market is picking up speed, which in turn is slowing economic growth substantially and pointing to a long recovery period ahead.
Consider first the most recent gross domestic product figures, which have generated quite the buzz since their release last month. The dramatic drop in annualized GDP growth between the third and fourth quarters of 2007—from 4.9 percent to an anemic 0.6 percent—is yet another sign the nation’s economy has entered a period of noticeable slowdown. We can’t declare a recession is at hand just yet; however this is not a one-quarter phenomenon but rather the reflection of a longer-term trend. Annualized GDP growth stood at 2.2 percent for 2007, down from 2.9 percent in 2006 and 3.1 percent in 2005.
At the heart of the current slowdown is a substantial weakness in the domestic housing market. As data from the Bureau of Economic Analysis show, the decline in the housing sector for the past two years was already the largest damper on economic growth since the mid-1970s. As of the end of 2007, the country has experienced eight consecutive quarters of declining growth in fixed residential investment—the longest decline since the downturn that took place between the second quarter of 1973 and the first quarter of 1975.
Over the past two years fixed residential investment, defined as spending on new homes and home extensions, lowered economic growth 0.87 percentage points below where it otherwise would have been. This is the most substantial drain on economic growth originating in the housing sector since 1975, when the average annualized growth impact of the housing sector subtracted 1.17 percentage points from the growth rate for that eight-quarter-long contraction in fixed residential investment.
Additionally, the size of the growth effect of the current housing downturn is more than 2.5 times the size of the last downturn in the mid-1990s, and more than 3.5 times the size of the average negative growth effect of the housing downturn in the late 1980s (See Figure 1 below).
What’s worse, the current two-year-long housing market downturn shows few signs of ending anytime soon. The growth contribution from fixed residential investment has turned increasingly negative for the past two years. In annualized terms, the percent contribution of fixed residential investment to GDP stood at -0.97 percentage points of economic growth for 2007, compared with -0.29 percentage points for 2006 and 0.39 percentage points for 2005.
Similarly, the downturn in the housing market accelerated at the end of 2007. In the fourth quarter, the housing market lowered GDP growth by 1.18 percentage points below where it otherwise would have been—an acceleration that followed the adverse negative effect of 1.08 percentage points less GDP growth because of the housing market downturn in the third quarter of 2007. The adverse effect of the housing market downturn on economic growth in the fourth quarter was the largest since the third quarter of 2006.
Unfortunately, there are signs that the housing slump may not only last for a while, but also may get worse before it gets better. Consider two key indicators of the future performance of the housing market—changes in permits for new buildings and changes in the number of housing units, specifically new housing sales. Both changes in housing permits and housing starts have become increasingly negative (See Figure 2 below). Housing permits in December 2007 were 34.4 percent below the level of December 2006, and the number of housing starts was 38.8 percent lower.
These are the largest declines since January and February 1991, respectively. They also represent increasingly large declines. The key indicators of future performance in the housing market are dropping at an ever faster rate, which could signal that new home sales that matter for economic growth will also turn increasingly negative. We may not have seen the worst of the housing recession yet.
If the current acceleration in the decline of residential fixed investment continues, the adverse effect on economic growth may exceed that of the 1970s. Already, recent signs show that the housing market downturn will continue well throughout 2008. Pending home sales statistics from the U.S. Census Bureau, for example, showed an unexpected decline, falling by 1.5 percent in December 2007 relative to the previous month, and by 24.2 percent compared to December 2006.
Even if the decline in the growth rate of fixed residential investment doesn’t worsen, it is still likely to last for a long time. One way to identify swings in the housing market is by comparing house prices to rents. Previous housing recessions experienced peaks in this prices-to-rents ratio in 1979 and 1987, but this ratio in both periods was smaller than the one today. Given the current long-run average ratio of house prices to rents, it will take 22 quarters to bottom out. Earlier analysis suggests that we are only three quarters into this 22-quarter cycle, and have at least four and a half years to go before we see the end of it.
The downturn in the housing market is taking a much larger bite out of economic growth than it has in recent decades. Something else, such as consumption spending, business investment, government spending, or export growth, needs to compensate for housing. Recent economic data, however, do not indicate these other areas are necessarily up to the job at the moment, which strengthens the case for government policy intervention in the housing market. In fact, problems in the U.S. economy appear to be getting larger by the month, which is why we need to do whatever we can to dampen the length and affect of the housing market decline.
The Center for American Progress has two proposals that work in tandem to achieve this goal. First is the Saving America’s Family Equity, of SAFE loan program which is modeled after the New Deal’s successful Home Owners’ Loan Corporation but uses existing government agencies and government-sponsored housing institutions to purchase pools of loans at current value and refinance those loans that are in default or have negative equity into fully amortizing, fixed-rate loans based on the current value of the property.
Our second proposal, the Great American Dream Neighborhood Stabilization Fund, or GARDNS Fund, would provide money to local housing authorities and non-profit organizations to buy foreclosed properties from banks and return them to productive use as affordable housing. Taken together, these two proposals can stabilize neighborhoods and restart frozen housing markets by significantly reducing excess inventory and moderating downward pressure on home prices.
Both measures would help the housing market find its footing, which in turn would help struggling homeowners cope with the downward spiral in housing prices and thus help the larger economy to recover again. These are steps that Congress needs to consider now. Waiting for the next Congress and the next administration to consider these plans may well ensure the current housing downturn does indeed last another several years.
For more information about the Center for American Progress’ policies on the housing crisis, see: