As housing goes, so goes the US economy?

Researchers say that the recent housing downturn doesn't necessarily mean an end to economic growth.

By , Staff writer of The Christian Science Monitor

Evidence keeps piling up that the housing sector, after fueling the American economy with its historic boom, is now in a recession.

Usually, housing downturns precede broader recessions in the whole economy. But this time, forecasters say that, for a range of reasons, the economy may continue on a path of growth.

The decline in home prices and sales volume has ripple effects, to be sure. Wednesday, the Commerce Department reported that the economy grew at a 2.2 percent annual pace in the quarter from July through September, a slower pace than earlier this year. A main reason was the slump in residential construction.

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But housing and the rest of the economy may be traveling on divergent tracks. In 2001, the last time the nation was in recession, housing did well as home prices continued to climb. Now, the reverse appears to be occurring.

"Typically in the past when housing fell into a recession so did the economy," says Ed Yardeni, chief economist at Oak Associates, an investment firm in Akron, Ohio. This time, "the rest of the economy is growing quite well.... There seems to be a certain amount of resilience."

Weathering the housing slump won't necessarily be easy.

This week, the median sales price of previously owned homes took its biggest tumble ever, falling 3.5 percent in October from the level one year ago to $221,000, according to the National Association of Realtors.

The housing slump hurts the economy in several ways.

There's lower construction spending, falling purchases of appliances, paint, and other home-related goods, and a negative "wealth effect" that affects consumer spending. As home prices dip, homeowners have less equity in their homes, or less money to spend.

Of the 13 occasions when residential construction turned negative on a year-over-year basis, recessions followed 10 times, according to research by the investment firm Merrill Lynch in New York.

Several factors, though, suggest that the current housing downturn may not drag the wider economy into recession:

• It usually takes more than just a housing contraction to cause an economy-wide recession. Although construction and home sales have often preceded past recessions, some other factors – a drop in government spending on defense, a jump in oil prices – have also contributed to a wider slump.

• The Federal Reserve is learning more about what it takes to guide the economy to a "soft landing." The Fed's goal is to remove inflationary pressures from the economy while not causing a recession by squeezing the credit environment too much.

As in the past, interest-rate hikes by the Fed over the past two years have cooled the housing market. The policymakers have stopped raising rates for now, watching to see whether they can thread the needle just right. Often past efforts have failed, but most economists think the Fed will avoid causing a recession this time.

• The market for home mortgages is very different than in 1990, when the last big housing crunch occurred. Now, when people get a mortgage, the loan generally doesn't stay with the bank that originated it. Instead, loans are packaged in bundles and sold to investors who reap the stream of monthly income from homeowners.

The upshot: The housing market's risk is diffused more widely, so banks face less pressure to cut back on lending during housing downturns.

"One of the important developments on the capital markets since the mid-1980s is securitization" of loans, Mr. Yardeni says. In this housing slump, banks are still lending, and their stocks are doing well on Wall Street.

• While the housing downturn is steep, its effects on consumers may be smaller than many fear. Surging home prices have added trillions of dollars in wealth to homeowners. That won't all be wiped away by a 3.5 percent decline in home values, or even by a 10 percent decline, which some forecasters say is possible.

Moreover, any negative "wealth effect" from home values promises to be offset by rising incomes. In the current job market, with unemployment near record lows, wages are on the rise. It's hard to know how long that pattern will continue, but it will help offset the impact of home prices.

"Income is 10 times more important than wealth" as driver of the economy, says Richard Berner, US economist at the investment house Morgan Stanley in New York.

That's a key reason he expects the economy to escape a recession next year.

"This isn't bulletproof," he says.

The risks are that the housing recession could fall deeper than analysts expect, or that energy prices could spike higher again.

Oil has edged back above $60 a barrel this week, trading close to $62 Wednesday morning. That's still well below its peak of around $75 a barrel this summer.

The stock market shows little worry of recession among investors. Stock prices rebounded Wednesday despite the rise in oil prices, with the Dow Jones Industrial Average well above 12,200 in morning trading.

In a speech this week, Federal Reserve chairman Ben Bernanke described a generally strong economy, where inflation was a greater concern for policymakers than the risk that the housing sector will put too much of a drag on economic growth.

"Although residential construction continues to sag," he said, "some indications suggest that the rate of home purchase may be stabilizing, perhaps in response to modest declines in mortgage interest rates over the past few months and lower prices in some markets."

For both new and existing homes, the pattern this year has been of sales volume declining and prices weakening – but not necessarily every month. Wednesday for example, the government reported that new-home prices rose in October even as sales fell sharply.

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