The near future of the housing market, in the eyes of economic forecaster Edward E. Leamer, is a case of mind over models. Several statistical models suggest the nation may be headed toward recession, but he disagrees.
“The model has been leading us astray. It is not a real recession. It is a slowdown — slower growth and weaker job formation,” said Edward Leamer, director of the University of California, Los Angeles, Anderson Forecast, released today.
“Our view is we’re moving into uncharted territory.” While there will undoubtedly be job loss in the housing sector with the cooling real estate market, Leamer said that the manufacturing sector “is not poised to contribute much to job loss,” and most of the job loss in past recessions has been in the manufacturing sector.
If economic conditions change and the manufacturing sector does see major job loss, “then we’ll call for a more extreme outcome,” Leamer said.
Recessions have been somewhat cyclical, Leamer notes in the report, occurring about once every seven years since 1950. “Many models say that a recession in the next 12 months is a virtual certainty,” though Leamer’s Anderson Forecast report, “Models or Minds?” states that “this time, unlike every other time, the problems in housing will stay in housing. If you are a builder or a broker, it will feel like a deep depression. But the rest of us will hardly notice.”
The report also states that interest rates still remain low, “and there is no evident credit crunch, now or on the horizon.” Coupled with the expectations for no major job loss from the manufacturing sector, “these facts make the problem in housing less severe than it would be otherwise, and both help to confine the pathology to the directly affected real estate sectors: builders, real estate brokers and real estate bankers.”
Markets that have relied heavily on the housing sector for economic growth, such as some areas in the South and Southwest, may experience localized recessions, Leamer said.
The disconnect between home prices and affordability became pronounced in the past five years, he said, and it is “going to take some time” for pricing to return to more sustainable levels, he said. “I think the boom was a fairly normal one in the 1990s and didn’t really get out of control until 2002 … (when) we had five years of extraordinary appreciation.”
The forecast report calls for housing starts to bottom-out at an annual rate of 1.4 million in second-quarter 2007, compared with a rate of about 2 million units per year during the boom. New-home prices are expected to hit a low in third-quarter 2007 at about 10 percent less than the current prices, Leamer’s report states, with existing-home prices “expected to nudge down a bit, but not nearly as much as new-home prices.”
A separate Anderson Forecast report released today states that a decline in housing starts to an annual rate of 1.1 million units would significantly increase the risk of “tipping the economy into recession.”
Leamer expects the Federal Reserve to cut the federal funds rate from 5.25 percent to 4.5 percent by fourth-quarter 2007 “in the hope of stimulating an economy,” according to his report. “Even though that rate cut cannot help housing and autos this time, because both are overbuilt, the Fed will be able to take credit as the economy naturally recovers.”
A separate Anderson Forecast report, “The California Report: Three Things to Watch in 2007,” predicts that the housing slowdown will slow the state economy but won’t likely drag it into a recession.
“While both building permits and construction employment have fallen faster than we predicted earlier in the year, other sectors have fared a little better than we expected, leaving the California economy as a whole growing slower than it has been, but slightly faster than we predicted,” states Ryan Ratcliff, an economist for the Anderson Forecast.
There is some ambiguity in the state’s economic outlook, though — the report notes that the circumstances surrounding the housing boom “sound eerily familiar” to the days of the dot-com boom in the state.
The temporary surge in revenues for the state could disappear with leveling home prices and shrinking home sales volumes, “just like the revenue gains from the tech boom,” the report states.
Year-to-date job creation in October was 36 percent lower than it was for the same period in 2005, Ratcliff notes, and 2007 “will hold just as much if not more real estate-related job weakness.”
There is an academic debate over how much a stagnation in home prices will disrupt consumption, and the report notes there has already been some mild slowing in consumption and retail sales “but nothing that suggests that housing wealth effects will sink the U.S. economy.”
The state’s construction sector will continue to weaken, with residential permit activity and construction employment hitting a low point in late 2007, the report states. “A budge-related shock from (state capital) Sacramento looks almost unavoidable, but … there may be some room to maneuver on the timing of this crunch.”