The importance of housing to the U.S. economy
- The U.S. economy typically gains direct and indirect benefits from increased housing activity.
- Housing starts have risen to more than 900,000 -- almost doubling the lows of 2009.
- Small businesses also could feel the effects of an improvement in housing.
Vice President, Global Economist
Recent data indicate the U.S. housing market finally may have recovered from the impact of the financial crisis that began in 2008. Waddell & Reed Global Economist Derek Hamilton explains why this change could have widespread positive implications for the U.S. economy.
The Great Recession that began in 2008 crushed the U.S. housing sector. The number of housing starts fell from a prefinancial crisis peak of more than 2 million units to a low of less than 480,000 in the first half of 2009.1 Housing prices declined more than 30% from their peak in 2006 to their low point in 20122 and foreclosures skyrocketed. Taken together, the data all seemed to show that the American Dream of owning a home had been shattered.
Fast forward to today. Housing starts have risen to more than 900,000 recently, almost doubling the lows of 2009. Housing prices have risen by roughly 8% since the bottom in early 20123 and the number of foreclosures has fallen. It seems housing finally may have turned the corner. We believe this is an important change that could have implications for construction activity, consumers and the economy as a whole.
Housing market background
In the post-World War II era, housing as a percent of gross domestic product (GDP) averaged 4.5% to 5%. However, in the few years leading up to the Great Recession, housing peaked at more than 6% of GDP. And housing prices rose almost 90% from 2000 to their peak in 2006,4 boosting job growth, consumer confidence and overall economic growth. All of this occurred on the back of easy monetary policy and regulation. When the housing bubble burst in 2008, housing activity and prices plummeted. In fact, housing as a percent of GDP fell to about 2% and even now is only 2.5%. The number of jobs in housing-related industries collapsed, resulting in a further drag on economic growth.
As the Federal Reserve (Fed) responded to the financial crisis, interest rates came down dramatically. This typically would have resulted in a turnaround in housing. In fact, the housing sector historically has been very sensitive to interest rates and one of the earliest parts of the economy to respond to lower rates. However, housing was experiencing structural problems during the crisis, including prices that had risen too high and overbuilding in parts of the country. So when housing plummeted this time, it stayed at depressed levels despite the lower interest rates. Even with short-term rates near zero, the Fed recognized the importance of housing to the recovery by purchasing mortgage-backed securities (MBS) over two separate periods. The most recent began in September 2012.
Lower mortgage rates coupled with lower housing prices brought housing affordability to record low levels. As the excess supply of homes started to shrink and demand started to increase, prices stabilized and began to rise.
Impact of housing recovery
Now that the housing market seems to be turning, we think the U.S. economy should improve further because housing affects it on a number of levels. First, there is a direct effect from construction activity. When construction activity increases, demand for construction materials starts to increase and other industries also gain a benefit. For example, the pace of lumber production is up almost 50% from its low following the recession.
In addition, housing is an important contributor to job growth. The National Association of Home Builders has estimated that about three jobs are created from every single-family home built and about one job from every multi-family rental unit built.5 This benefit comes from more than just the construction of the building since a variety of industries are affected, from architects to Realtors to mortgage brokers. After a significant lag because of the recession, single-family construction is increasing. In our view, this increase combined with multifamily building activity should boost employment and benefit the economy.
The economy typically also gains an indirect benefit from increased housing activity along with these direct benefits. Consumers tend to become more confident as housing prices increase. Homeowners no longer worry about falling home prices hurting their personal “balance sheets,” since the house typically is the most valuable asset. In fact, when home prices rise and household balance sheets improve, consumers typically begin to feel more confident about their overall financial situation. Various studies have shown that an increase in housing wealth ultimately leads to higher consumer spending. If housing prices continue to rise at the current pace, then we think consumer spending could increase by 0.3% to 0.4% over the next year.
Small businesses also could feel the effects of an improvement in housing. Roughly one-half of all private-sector jobs come from small businesses, so they are critical to the U.S. economy.6 But small businesses have been under pressure since the recession. While credit availability has improved for large corporations, it has grown more modestly for many small businesses. Many small business owners also own a home, and some of those homeowners use it as collateral for a business loan. As housing prices rise, these individuals may see improvement in their balance sheets, potentially allowing them greater access to credit. Thus, we believe that improving health for small businesses will ultimately result in stronger growth in the U.S. economy.
Outlook for continued recovery
Housing activity is well below its long-term average relative to GDP. In addition, demographics indicate there is strong demand for housing. A study done by researchers at Harvard University forecast that about 1.64 million new homes would be needed each year from 2010 to 2020, based on demographic trends.7 If accurate, that indicates a rapid pace of construction activity would need to continue for several years in order to keep up with housing demand.
There certainly are risks to the housing recovery story. Interest rates are extremely low now and any reversal in policy by the Fed that results in much higher interest rates could disrupt that recovery. Furthermore, following the Great Recession and the housing crisis that resulted, it is possible that some individuals may change their views about home ownership. Nevertheless, because of activity already under way and the potential for continued benefits, we believe in the housing recovery story. We think it will continue to have positive effects on the U.S. economy going forward.
1 – U.S. Census Bureau
2, 3, 4 – S&P/Case-Shiller Home Price Index
5 National Association of Home Builders, “The Direct Impact of Home Building and Remodeling on the U.S. Economy,” October 2008
6 U.S. Small Business Administration
7 Joint Center for Housing Studies, Harvard University, “Updated 2010–2020 Household and New Home Demand Projections,” September 2010
Past performance is not a guarantee of future results. The opinions expressed in this article are those of Mr. Hamilton and are not meant to predict or project the future performance of any investment product. The opinions are current through April 10, 2013. Mr. Hamilton’s views are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
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