Is Reliance on Real Estate a Crack in the Foundation?

By Neil Irwin
Washington Post Staff Writer
Wednesday, April 5, 2006

The U.S. economy is more dependent on housing than it has been in a half-century, as the sector fuels consumer spending and has accounted for nearly three-quarters of the nation's job growth in the past five years.

As a result, economists worry that the housing slowdown that began late last year could hurt the broader economy more than past real estate downturns, although other parts of the economy appear to be accelerating.

What makes the real estate boom of the past decade unusual is that its effects have reverberated far beyond closely related sectors such as construction, driving sales in places as varied as furniture stores and motorcycle showrooms, especially in the Washington area and others where home prices have soared particularly rapidly.

"People know they can always refinance or flip their houses, so they are willing to spend more," said Matt Ross, sales manager at Coleman PowerSports in Falls Church, who figures that at least 20 percent of his sales of motorcycles, motor boats, and jet skis are to people who pay for their purchase using home equity.

By almost any measure, the U.S. economy is built on housing more than in the past. In 2005, investment in housing constituted a higher proportion of the goods and services the nation produced than it has since 1950, when the nation was experiencing a massive postwar housing boom. The proportion of jobs in real-estate-related fields is the highest it has been since at least 1970.

Locally, there is strong job growth in sectors other than housing. The value of home transactions in the region was nearly as high as federal procurement spending in the region last year, though each dollar spent by the government generates significantly more economic activity. But Washington area residents took more money out of their houses through mortgage refinancing and home equity loans, as a proportion of income, than those in most other cities, which could mean local consumers' spending has depended more on housing than in most places.

Now the companies that have benefited from this expansion are bracing for the great unwinding. The nation appears to be entering a period in which the role of housing in the economy is returning to something more resembling its historical norms.

A small group of economists argue that housing prices in many parts of the nation, including the Washington area, have so outstripped those supported by economic fundamentals, such as income levels, that they are due for a painful and rapid correction that could cause a recession. But most mainstream economists believe that the unwinding of the housing market's outsize role in the economy will be gradual and come just as other industries take over as economic drivers.

Nationally, the number of homes sold declined every month from August to January, according to the National Association of Realtors. Builders started work on 4.8 percent fewer units of housing in February than a year earlier, following years of sharp increases in construction.

So far, the housing slump appears not to have caused much economic distress, but the consensus of Wall Street economists' predictions is that growth will slow in the second half of the year, in part due to the housing slowdown.

"Clearly, housing is going to be a drag on the economy; the question is how much does housing slow and how quickly," said Dean Baker, co-director of the Center for Economic and Policy Research and a certified housing bear who expects a housing slump that will lead to recession.

A more common view among economists is that a cooling in the housing market would be only a mild drain on the economy.


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