Real Estate Slowdown Won't Cause Recession

If history is any indication, the country may be heading for a housing crash, according to the Anderson Forecast, a product of the University of California, Los Angeles.



"The risk of a housing crash rather than a slowdown is far greater than what most people think. In fact history is on the side of a crash," stated David Schulman, a senior economist for the UCLA Anderson Forecast, in his report, "Housing, Inflation and the Fed," released today. He added, "Every major housing cycle of the past 45 years ended with activity declines in excess of 50 percent. Because the current cycle was so powerful, why should we expect any less?"



The report also notes that the blame for a real estate bubble may fall on the Federal Reserve Board. "There is some truth to the notion that the Fed created the housing bubble to prevent the deflationary forces of collapsing stock prices to take hold in the real estate economy."



But now, the housing market is becoming a drag on the overall economy. "The driving force behind both the slower growth and the rising inflation is the housing market. The great housing boom of the past five years is unwinding under the weight of higher interest rates and unsustainable home prices," Schulman states in the report.



He also suggests that the Fed "is in a box" because it is faced with rising inflation and a decline in housing activity. Ultimately, the housing market could be a casualty as the Fed works to curb inflation. "Central banks lose their credibility for failing to fight inflation," said Schulman, who expects the Fed to raise the federal funds rate at least one more time, with "a long wait before the next easing."



In a separate Anderson Forecast report, titled "Homes and Jobs and Bonds," forecast director Edward Leamer stated that the nation's economic problems will be mostly concentrated in the real estate sector, though this "will not produce a national recession," at least unless the manufacturing sector continues to topple.



"The housing market is like a powerful rocket whose fuel has been exhausted," Leamer states. Some observers expect this "rocket" to pick up new fuel and begin to accelerate again, while others expect it to gradually glide back down and still others expect that it will crash and burn, the report notes.



Edward Leamer, UCLA Anderson Forecast

"Problems in housing have almost always led into recessions and attendant increases in unemployment that has amplified the housing adjustment. Our best guess is that this time, unlike all the other times, the problems will be mostly in real estate and will not produce a national recession," Leamer states.



Historically, cycles in manufacturing and construction were roughly parallel, "with peaks and troughs occurring very close in time." But after the 2001 recession, job cycles for these two industries became disconnected. Construction jobs recovered and made substantial gains, while manufacturing jobs, which fell by 3 million from 2000-03, "have been drifting sideways ever since," the report states.



Globalization and automation may have something to do with the lackluster employment numbers in the manufacturing sector, the report notes, though Leamer states, "we do not expect manufacturing jobs to suffer as much as in earlier housing-related downturns." Meanwhile, "it appears as though construction is ready for a tumble."



Leamer also notes that home prices rarely drop, "and if they do, the decline is not very much." Regionally, there hasn't been a significant housing bubble since 2001 in the Midwest. The bubble has cropped up in the South in sales volume, not prices. In the Northeast, prices "have recently entered the stratosphere above the normal band," but should return to more normal levels. "This is a region where sales of existing homes will plummet and the associated jobs for real estate and mortgage brokers will suffer," the report states.



And in the West, "both prices and volumes (got) out of control in the last several years. Prices ... are starting to fall back to the normal band, but have another 10 percent to get back into the normal range."



The Anderson Forecast also includes a California-specific report by economist Ryan Ratcliff, titled "The California Report: At the Tipping Point," which concludes that construction employment will peak in the state in the third quarter before losing 100,000 jobs by 2008. Finance employment and manufacturing employment should remain flat in the state during this period, according to the report.



As with the national forecast, the statewide forecast predicts that the real estate slowdown will not produce a recession or a substantial decline in average home prices.



But there are some unknowns that complicate the forecast, such as the unprecedented use of exotic mortgage products that represent a "potential squeeze ... on consumer finances. A substantial slowdown in consumption spending could certainly tip the economy into a recession, and distress sales from home owners squeezed out by an adjustable mortgage reset could all lead to a more severe drop in average home prices than we are predicting." Sustained declines in home prices are "extremely rare," though, and typically only occur during recessions.



If there is another round of job losses in California's manufacturing industry, "all bets are off," Ratcliff states. "Oddly, the fate of California's housing market may hang on a sector that has nothing to do with housing."



By Glenn Roberts Jr.