We Americans love our homes. The richer we get, the bigger they get. Since 1987 the average size of a new home has increased 22 percent; and of course, we stuff them with more and more conveniences. Even the laundry room, home furnishing experts advise, should now have a sofa, TV and DVD player. Gulp. The good thing about the housing boom is that it has steadied an otherwise-shaky economy -- which is why signs that it may be faltering are so troubling.
The timing is dismal. All the indicators in the past month suggest a rapidly deteriorating economy: Consumer spending (two-thirds of the economy) dropped in January and February, after adjustment for inflation; in March the number of payroll jobs declined 108,000 (the loss since early 2001: 2.1 million); surveys by the Institute for Supply Management, a business group, find that both the manufacturing and the nonmanufacturing sectors are shrinking. A grim picture.
Economic forecasters have minimized these setbacks by attributing them to the war in Iraq. Companies "just don't want to invest until they know what's going to happen," says economist David Wyss of Standard & Poor's. Once fighting stops, the theory goes, businesses will raise investment and hiring; consumers will travel and spend more confidently. Wyss foresees meager economic growth of about 2 percent (at an annual rate) in the first half of the year; but he expects it to rise to 3 percent or more in the second half.
Could happen. This "consensus forecast" is widely believed. Federal Reserve Chairman Alan Greenspan apparently subscribes to it. But it could also be overly optimistic, as many recent forecasts have been. If so, housing could be a weak link.
Low (and falling) interest rates and high (and rising) home prices created the boom. Housing generally became more affordable as lower rates offset higher prices. Existing homeowners sold and "traded up." If they didn't sell, they refinanced their mortgages at lower interest rates, reducing their monthly payments or generating instant mounds of money. (In a "cash out" refinancing, the amount of the new loan exceeds the amount of the old; homeowners collect the difference and convert higher home prices into cash.) All this provided two economic jolts.
First, feverish construction and home buying. In 2002 new home starts totaled 1.7 million units, 7 percent higher than in 2001 and 9 percent higher than in 2000; meanwhile, existing home sales were a record 5.6 million, up 6 percent from 2001 and 9 percent from 2000. People who move often need (or want) new appliances, furniture and carpets. There was job creation galore -- for construction workers, real estate agents, mortgage brokers, movers and (some) factory workers.
Second, ordinary shopping. People spent some of the extra money (from those "cash outs'') at the mall. Or they remodeled their homes. Or they paid down higher-cost credit card debt. One way or another, purchasing power improved. The volume of "cash outs" is staggering. In 2002 mortgage refinancings totaled a record $1.5 trillion of total new mortgage loans of $2.5 trillion (the rest went to buy homes), says economist Frank Nothaft of Freddie Mac, a mortgage company. He reckons that consumers took away $90 billion in cash, up from $80 billion in 2001. Other estimates run twice as high or more.
It would be a calamity if the housing boom, like the stock boom before it, turned out to be a "bubble." In a recent speech, Greenspan dismissed the comparison as a "stretch." Most economists agree. For starters, people don't buy and sell homes like stocks. It's too costly and inconvenient. They have to live somewhere. Next, home prices haven't risen nearly so rapidly as stock prices did.
Let's see. Stocks (as measured by the S&P 500 index) rose 20 percent in 1996, 31 percent in 1997, 27 percent in 1998 and 20 percent in 1999. By contrast, the median price of existing homes increased 7 percent in 2002, 6 percent in 2001 and 4 percent in 2000, says the National Association of Realtors. Increases in some metropolitan areas have been higher: 20 percent last year in New York and Los Angeles, 16 percent in Chicago, 14 percent in Washington and 10 percent in Boston. Still, the overall picture is less extreme.
The danger is less a total collapse than a gradual descent. The two props of the boom -- falling interest rates and rising prices -- both seem wobbly. In 2000 rates on 30-year fixed mortgages averaged 8.1 percent; recently they've been well below 6 percent. Any further decline might perversely signify a much weaker economy. As for home values, they seem 15 percent overpriced by historical measures, estimates economist Cary Leahey of Deutsche Bank. He doubts that prices -- except in some localities -- will drop but suspects that they won't rise much for the next three or four years.
Well, there goes the boom. Refinancing proceeded from lower rates and higher prices; though still strong, it may peter out. Stable prices might also slow home buying because people wouldn't fear being priced out of the market. Alone, a modest housing slowdown wouldn't be damaging. But it could be devastating in combination with a broader lapse in consumer spending. A post-Iraq economy could disappoint.
The vulnerability is proportionate to Americans' elevated attachment to their homes -- generally, a family's biggest status symbol and financial asset. Higher home values have provided confidence and cash in an otherwise unhappy economy. Losing one or both could, by making consumers even more cautious, turn gloomy economic forecasts into self-fulfilling prophecies.