Housing Hurts, Bernanke Says

By Nell Henderson
Washington Post Staff Writer
Thursday, October 5, 2006

The "substantial" slump in the housing market is likely to slow U.S. economic growth by about a third in the second half of this year and dampen growth early next year, Federal Reserve Chairman Ben S. Bernanke said yesterday.

Growth in the nation's output of goods and services will probably be shaved by a full percentage point, Bernanke said in response to questions after a speech at the Economic Club of Washington. Assuming that means the economy grows at a 2 percent annual rate during those months rather than at its average pace of around 3 percent, the value of domestic output will be about $15 billion less, adjusted for inflation.

"As you know, a substantial correction is going on in the housing market," Bernanke said, using stronger language than he had in recent months, when he described the real estate cool-down as "orderly." The process is one of the "major drags causing the economy to slow," he said.

But Bernanke said "other parts of the economy remain very strong." And he emphasized that despite the slowdown in economic growth, "the Federal Reserve remains concerned about inflation," which is above the central bank's desired level. He reiterated his position that overall, inflationary pressures are a greater risk to the economy than the housing slowdown.

His remarks yesterday helped boost stock prices, which had been rising even before his midday speech. Wall Street traders were relieved that Bernanke expects only limited economic damage. But his comments also doused some investors' hopes that the Fed might cut interest rates in coming months to prevent the housing market from dragging down the rest of the economy.

Bernanke's comments were the first in which he has publicly put a number on the likely economic effects of recent drops in home sales, spending on home construction and the rate of home-price appreciation.

The economy slowed sharply to a 2.6 percent annual rate of growth in the third quarter, from a 5.6 percent annual rate in the first quarter. Much of the decline reflected a slowdown in consumer spending, which was crimped by rising fuel prices and interest rates, as well as a plunge in housing construction.

The housing market continued to weaken through the summer, prompting debate among economists about how long the slide will continue and how large a toll it will take on the rest of the economy.

The optimists, including many Fed policymakers, think the economy will rebound next year with little serious damage. The pessimists worry that a deep, protracted downturn in housing will cause consumers to cut their spending, pushing the Fed to lower interest rates early next year to prevent a recession.

"How far will the correction go?" Bernanke said, posing the obvious question before appearing to duck it. "It's very difficult to tell, is the honest answer."

But Bernanke gave several reasons to expect the housing market to level off and eventually bounce back, including low unemployment, rising incomes and low mortgage rates. The Mortgage Bankers Association reported yesterday that the number of loan applications rose strongly last week.

Although sales of previously owned homes fell in August, some analysts saw signs that the market might be stabilizing, noting increases that month in both new-home sales and pending sales, in which contracts have been signed but the deals have not yet closed.

Bernanke said the housing market has not hurt the rest of the economy so far. He cited robust spending on the construction of factories, offices, hospitals and other nonresidential projects.

Other analysts who share his view say consumer spending has slowed this year but has held up pretty well given the spring and summer surge in fuel prices. Oil and gasoline prices have fallen since mid-August, which should give households more cash to spend and help cushion the economy's slowdown. Vehicle sales, for example, rose in September after falling in August.

Bernanke said the Fed would watch closely to see how the housing downturn affects consumer and business behavior. But when asked about the greatest risks facing the economy, Bernanke ranked inflation above the housing market. Consumer prices rose 2.5 percent in the 12 months ended in August, as measured by the Fed's preferred Commerce Department inflation index, which excludes food and fuel prices. Before he became chairman, Bernanke often said the Fed should strive to keep inflation to 1 to 2 percent.

Bernanke said he and his Fed colleagues think inflation will come down gradually over time, but he would not want to let it stay where it is or to rise.

Among the challenges facing the economy in the long run, he said, is the aging of the population -- the topic of his speech. By 2030, when most of the baby-boom generation will have retired, 19 percent of Americans will be 65 or older, he said.

And the population will continue to age after the baby boomers have retired because of rising life expectancy, he said.

"In coming decades, many forces will shape our economy and our society, but in all likelihood, no single factor will have as pervasive an effect as the aging of our population," Bernanke said. He said Americans should save more to prepare for the change.

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