Housing Bears May Just Have It Right for 2007
By Gene Sperling
Dec. 28 (Bloomberg) -- For economic forecasters divided over the strength of the economy in 2007, the elephant in the room remains the house, or more precisely, housing.
While very few forecasters predict growth of more than 3 percent for next year, and most agree that the cooling of the housing boom may hurt consumers, one major question remains: Is the worst over?
Housing played an outsized role in the most recent recovery. Beyond the surge in residential investment -- which accounts for 5 percent to 6 percent of the economy -- rising home prices and billions of dollars in home-equity extraction fueled household spending at a time of stagnant wages and low private saving.
Few dispute that a slumping housing market will have a depressive effect on consumer spending. What is less clear is whether we can now officially declare a soft landing, or whether we should expect more turbulence from the unraveling of the housing boom.
Some of the smartest economists in the U.S. now say the worst of the housing cycle is over. Indeed, two-thirds of economists in a recent Wall Street Journal survey answered affirmatively that ``the worst of the housing bust is behind us.'' Their case is that even after a 17 percent fall in new-home prices and a significant decline in home-equity withdrawal in the third quarter, consumer spending defied gravity and remained at 3.1 percent.
The Kohn View
These moderate housing bulls argue that construction starts have now fallen to the point where the excesses are being worked off and the demand should soon pick up. No less a wise man than Donald Kohn, the universally respected vice chairman of the Federal Reserve, argued in a recent speech that housing ``starts may be closer to their trough than to their peak'' and that any overbuilding in 2004 and 2005 would be worked off in coming quarters, assuming the current level of housing starts.
Translation: excess inventory is being reduced enough that it will soon be time to get the builders out there again, after barely a pause.
The problem is that none of the bulls seem to have a good answer to the facts being laid out by David Rosenberg, the chief economist for North America at Merrill Lynch & Co. Rosenberg's contention is that when you take a close look at homes for sale, including those being completed and those under construction, the glut in supply seems likely to get worse, not better.
Building Inventory
In a Nov. 27 comment, Rosenberg notes that in addition to the record 4.3 million residential units for sale as of October, there were 1.95 million home completions, the 12th-highest month since 1979. Units under construction were through the roof as well. Rather than seeing supply dwindle and prices start to firm up in early 2007, Rosenberg says ``it could be a year before the reduction in starts begins to put a meaningful dent into the inventory backlog.''
John Mauldin, an investment adviser and frequent contributor to Investors Insight, a financial-data publisher, throws an extra log on the fire. According to Mauldin, even the current projection of housing sales may be overstated and thus the existing supply of homes greater than what is reported in the official data. The reason is that the Census Bureau, one of the Commerce Department's statistical agencies, fails to account for cancellations in home sales contracts. Cancellations ran as high as 40 percent for some major homebuilding firms last quarter.
Triple Threat
If the bearish view on home inventories is true, it poses a triple threat next year.
First, it could mean that residential investment will remain a drag on growth for most of 2007. Second, home prices may fall more -- and home-equity withdrawal will continue to contract -- well into 2007. Third, construction jobs -- previously one of the brightest parts of the labor market -- might take a hit.
In this context, rising wages and a stronger job market would be a welcome cushion to a housing-induced blow to consumption -- and not the inflationary threat that some economists are concerned about.
Unfortunately, as the bearish Nouriel Roubini of Roubini Global Economics Service points out, the excess inventory that might slow the economy and hiring is not limited to housing.
In the third quarter, real inventory accumulation, excluding autos, rose to $58 billion, the highest level since late 2000. This excess inventory on the industrial side may already be taking its toll. The Institute for Supply Management's manufacturing report for November showed an index reading below 50 percent for the first time since April 2003, meaning that industrial activity contracted.
Unwelcome Combination
The combination of an inventory overhang in both housing and manufacturing provides significant ammunition for those who expect growth to be less than the 2.4 percent consensus estimate of the most recent Blue Chip survey.
This more depressing news must, of course, be balanced with positive signs. A survey of the Association for Financial Professionals found that 83 percent of those queried expected their companies to either increase or maintain their U.S.-based workforces. And all 12 equity strategists surveyed by Bloomberg News are projecting a bull market in 2007.
Nonetheless, as the new year approaches, the housing bears seem closer to getting it right than the Goldilocks crowd.
(Gene Sperling, author of ``The Pro-Growth Progressive,'' was President Bill Clinton's top economic adviser. He is a senior fellow at the Center for American Progress. The opinions expressed are his own.)
To contact the writer of this column: Gene Sperling in Washington at gsperling@cfr.org .
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