The Housing Crash Recession of 2007


Richard Moore

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    The Housing Crash Recession of 2007
    By Dean Baker
    t r u t h o u t | Columnist
    Tuesday 05 December 2006

As we approach the end of 2006, the economy's prospects for next year appear 
more gloomy with each new piece of economic data. And, just like President Bush 
in his assessment of the situation in Iraq, the economic forecasters are 
gradually revising their forecasts downward, as it no longer appears credible to
present the rosy pictures that they had been trying to sell.

The trouble began early in the year, when the housing boom that was supposed to 
continue forever turned into a housing bust. The rate of house price 
appreciation didn't just slow, as most economists predicted, nor did prices 
simply flatten in accordance with their revised predictions. House prices began 
to fall. Nationwide, house prices are now down between 1 percent and 2 percent 
from their levels at the same point in 2005. (The decline is between 4 percent 
and 5 percent, if we adjust for inflation.) The price declines in some of the 
most over-valued areas, like Washington, DC, and parts of Florida and 
California, have been considerably sharper.

In fact, the price declines are even larger than is shown in the data, because 
sellers now routinely make payments that are not captured in the contracted 
price, such as picking up some of the buyer's closing costs or making repairs to
the house before the sale. Such practices were unheard of a year ago.

When the downturn in the housing market could no longer be denied, the economic 
forecasters assured us that the rest of the economy would remain strong. They 
noted the strength in non-residential construction, strong investment in 
equipment and software, and of course the resilience of consumers.

This picture is not panning out well either. The non-residential sector 
experienced a short boom earlier in the year. This should not have been a 
surprise. The housing boom pulled resources (workers and construction materials)
away from the non-residential sector. In some of the areas with the most 
over-heated housing markets, it wasn't possible to get the workers needed to 
build stores, offices or other non-residential structures. This meant that when 
demand in the residential sector eased, resources could switch to meet the 
pent-up demand in the non-residential sector.

But, it was predictable that this boom would be short-lived. The residential 
sector is twice as large as the non-residential sector. And there just is not 
that much pent-up demand. There was serious overbuilding in the office and 
retail sectors in the late-90s boom, and the continued decline in manufacturing 
means demand for factory construction is limited. According to the most recent 
data, construction in the non-residential sector was already falling off by the 
end of the third quarter.

The boom in equipment and software investment also seems to have disappeared. 
The latest numbers in this sector have been negative also, suggesting that 
investment will be at best a very small positive in the economy in the next 

This leaves us with our resilient consumer. The economic forecasters assure us 
that strong job growth, coupled with healthy wage growth and falling gas prices,
will give consumers the money they need to keep spending.

Well this story does not look very good either. Job growth has actually been 
slowing over the course of the year, with the private sector adding less than 
100,000 jobs on average for the last two months. Falling gas prices are a 
positive, but since no one had expected gas prices to soar to $3 a gallon, the 
fact that prices have fallen back to last year's levels does not give consumers 
that much of a boost. Finally, we are looking at modest real wage growth (at 1 
percent annually), but this is not extraordinary and not enough to provide a 
very large boost to demand.

The more important part of the story for consumers is that they are losing the 
ability to borrow against their homes. Last year, consumers pulled more than 
$800 billion in equity out of their homes. Many people bought their homes with 
little or no money down, and then borrowed against their equity as quickly as 
their house price rose. Now that house prices have turned down, they have no 
further equity against which to borrow. This means that these consumers have no 
choice but to curtail their consumption.

The evidence for this falloff is spreading by the day. Projections of weak 
holiday sales and slumping car sales top the list. Throw in the reports of 
rapidly rising rates of mortgage delinquencies and defaults and you get a clear 
picture of rapidly growing distress.

Of course, with all sources of demand showing weakness, job growth will slump 
further, and we'll get our classic downward spiral: declining employment, 
falling income, falling consumption, and then further job loss. The story is not
pretty, but unfortunately there is no way to prevent it. This downturn will be 
especially painful because it is associated with a crash of the housing bubble. 
This means both that many people will lose their life's savings and also that 
the recession is likely to be longer lasting than most.

The picture would not have been so dire if economists had been better able to do
their job. Unfortunately, economic forecasters seem more interested in happy 
talk than economic analysis. Not one of the "Blue-Chip 50" forecasters saw the 
2001 recession coming. The record seems no better this time around.

Unfortunately, no one ever holds the forecasters accountable. Even though they 
all missed the last recession, and just about all of them will have missed this 
recession, the same group will probably still be around to miss the next 
recession. Some workers, like dishwashers and custodians, teachers and truck 
drivers, have to meet performance standards. Economic forecasters apparently 
just have to show up to collect their paychecks.

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