Even without a full-scale downturn in real estate, the dynamics of the housing market could exert a significant drag on economic growth in the next year and beyond.
By some forecasts, a slowdown in real estate could nearly halve the economy's growth rate by 2007. And though the threat of recession is generally viewed as distant, it's even conceivable that a softer housing market could set the stage for an economic slump.
Real estate sales and home construction have often bounced the economy up and down. But now, amid signs that higher interest rates are starting to cool the economy's hottest sector, there's an additional ripple effect for US consumers: less ability to tap home equity as a source of income.
That phenomenon, dubbed "equity extraction," has provided crucial cash to the economy in recent years, helping consumers consistently surprise economists with their ability to keep spending.
All this makes housing a pivotal indicator as the US economy enters 2006.
"It's the biggest issue for the year ahead," says Ed McKelvey, an economist with investment house Goldman Sachs in New York. "We are estimating a 1.5 percent potential hit" to America's gross domestic product (GDP).
Such a change wouldn't happen all at once. Housing market forecasts vary, but many economists say a cooler period could last for several years. And the impact on GDP, too, would be felt gradually.
For Mr. McKelvey, the biggest impact would come late next year and into 2007. Until then, any housing slowdown would scarcely register, according to Goldman Sachs. Its official forecast for next year shows GDP growing strongly at 3.6 percent, almost identical to this year. And other firms also have concerns about the ripple effects of a housing slowdown, tempered by the healthy state of the general economy.
For example: the Anderson Forecast, put out by the University of California, Los Angeles, this week predicted that the housing sector may already be slowing the economy, as of the current quarter. It predicted a sustained slowdown in housing that could last several years, according to a summary of the report by the Associated Press. The forecast stopped short of predicting a recession, but said that as many as 500,000 construction jobs and 300,000 financial-sector jobs tied to real estate could be lost as the cycle plays out.
Other forecasters are far more optimistic. Even in a "worst case" scenario, where home sales wouldn't just slow but housing prices would actually fall an average 10 percent nationwide, real GDP growth would be cut by only 1 percentage point, estimates Global Insight, based in Lexington, Mass.
The variation in forecasts reflects, in part, differing views on how much consumers have been relying on their homes as a source of income.
The low interest rates of recent years have empowered buyers to spend more for homes, pushing prices up. Those same low rates have allowed other homeowners to supplement their spending power by taking out home-equity loans or by refinancing their mortgages on better terms. That's the equity extraction factor.
Economists at Goldman Sachs are in the camp that sees a potentially significant impact on consumer spending if this factor wanes as a force in the economy. Coupled with slowdowns in homebuilding and home sales, it could crimp GDP. And in some scenarios, the result could be worse.
The risk is that this policy cuts too far into consumer spending, which accounts for 70 percent of GDP. "Once the economy's growth rate decelerates" below its normal pace, says McKelvey, "it doesn't take much to see the unemployment rate start to rise. It starts to gather its own momentum."
A recession in such circumstances is not unthinkable, he says.
Much will depend on the Federal Reserve. The Fed is currently steering interest rates upward to make sure that inflation doesn't accelerate. Some economists say another Fed goal, judging by comments by Fed officials, is to slow what it views as an overly hot housing market.
"That's what the Fed is looking for," says Brian Bethune, an economist with Global Insight.
Already, inventories of existing homes for sale are expanding. They rose to 4.9 months of supply in October. Some hot markets such as Boston have cooled noticeably.
Mr. Bethune says that as the housing market plateaus, the US job market shouldn't be affected dramatically. Construction workers who stop building homes may find other work in government or corporate projects, for example. And at any signs of a deeper downturn, he says the Fed will be ready to step in and shift interest rates back downward.