Impact of the Housing Sector on U.S. GDP Growth in the Coming Decade

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by: Nikhil Raheja
Housing construction is an important part of the US economy, constituting 5% of the total GDP. Thus, it is relatively important for this sector to remain stable for the whole economy to grow. Conversely, a sharp drop in housing starts may not necessarily translate into a recession, as long as the other industries continue to do well.

So far, housing indicators such as the housing starts and building permits have shown strength, while others such as housing prices and real estate loans made by banks, have stumbled. This report documents a fragile position for the housing sector, and thus portends sluggish growth for the economy as a whole.

Housing Starts and Building Permits: Housing starts rose 3.5 percent in May from April. While the building permits rose 8.7% during the same period. Such increases are a sign of hope amongst the builders, but increased construction can cause the supply of homes to rise out of proportion with the demand, eventually causing a decline in home prices.

Real Estate Loans: The real estate loans have continued to decline since mid-2009. The loans have fallen a cumulative 9% in the last 2 years. Most real estate is purchase with mortgages, and a decline in such loans has caused downward pressure on real estate prices.

Quantitative Easing (Supply Constraints): The Federal Reserve has propped up the housing market by purchasing Mortgage Backed Securities (MBS) since 2008. MBS are securities backed by a pool of mortgages. By doing so, the Fed increased liquidity in the banking system, hoping the banks would re-lend the money obtained from the sale. However, the banks decided to hold on to the money, thus allowing a decline in the total real estate loans made.

High Household Debt (Demand Constraints): In addition, mortgage rates are close to their all-time lows at 4.5%, 30 year mortgage. This is due to the lower demand for mortgages by the overextended consumers. By last count, the total household debt of US households was close to 100% of the GDP. As a result, consumers wish not to acquire more debt, and instead pay off their current debt.

Historically, such deleveraging (paying off the debt) has taken at least 10 years to come to a close, causing historical slumps such as the Great Depression, and the Japanese recession of the 90s. It can be said with reasonable certainty that the high debt in the US would reduce the total mortgages for the coming years.

Tax Credit: In addition, with the expiration of the tax credit for home buyers, another source of encouragement has been lost. The tax credit reduced the taxable income for first time home buyers who purchased homes during 2008, 2009, and 2010. This was a valuable incentive to purchase a home.

Home Prices:

Home prices are down 5.1% from a year ago, and are at levels below those seen in 2009. Prices in the country have fallen consistently for 3 quarters. Also, they are now down 32.7% from their peak set five years ago.

Conclusion: Home prices can fall for a variety of reasons, ranging from low aptitude for debt, to fewer loans available, or due to fear of a fall in home prices in the future. But a fall in prices, regardless of its cause, will have the effect of reducing total construction in the country. This would lower the total income generated in the housing sector and reduce total spending, thus causing some downward pressure on the GDP.

It is difficult to predict what the attitudes of the home buyers would be, but our best guess is that housing would be a slow engine for growth in the US economy for the coming decade.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.