Wait, here's something! We are coming to houses, their windows brightly lit. Perhaps they will show us where we are.
Houses. What could be more solid, more fundamental? With apologies to the British poet Philip Larkin, we might say that houses (rather than "days") "are where we live." (What a wonderful line: Larkin's rather than Campbell's.) The market for houses in the key global economy, that of the United States -- the booming market for houses -- may throw some light on where the U.S. economy and, by extension, the world economy is heading.
The National Association of Realtors provides much useful information about the U.S. housing market. This week it informed us that "existing-home sales increased by 5.5 percent in October to a seasonally adjusted annual rate of 5.17 million units from a level of 4.90 million units in September." Sales in October were up by 2.0 percent on October 2000. Not only did existing home sales rise over the terrorism-depressed month of September but they climbed year-on-year as well. Hardly the stuff of recession, is it?
Perhaps the trail we are on is not so bad after all -- one heading to safety. That, certainly, is how the NAR's chief economist, David Lereah, appears to see it. Tuesday he said, "Three weeks after the Sept. 11 attacks, some of our major brokers were reporting that sales had recovered to 95 percent of pre-attack levels. While we have some way to go before we reach record activity again, this demonstrates the strong demand and favorable affordability conditions that exist in today's housing market," he said.
Record activity? But your correspondent thought we were lost in the woods, directionless, worried, lost, unable to decide anything, let alone the most important and expensive purchase of all, that of a house. What's going on?
The NAR's expectation is that there will be 5.19 million existing-home sales this year, the second highest figure on record, up 1.3 percent from 2000. Existing home sales have exceeded the 5 million mark only twice: in 1999 and 2000. The NAR president, Martin Edwards Jr., said Tuesday that, from a historical perspective, home sales remain strong: "We've had only two years where existing-home sales have hit the 5 million mark, and we're well above that for this year," he said. "Going forward, we're looking for an upturn in the spring, with total sales in 2002 essentially matching this year's strong performance."
From what the NAR terms a historical perspective, housing sales are not just "strong": They have been running in the past three years at all time record levels. Perhaps now there is a slight downturn, but the NAR expects "an upturn in the spring." Well, of course, spring is a fine time in the woods but, again, this seems strange. Is not a booming housing market normally found in a booming economy? Perhaps, then, this is a sign that all will be well, that soon the U.S. and global economy will be recovering strongly?
It is not just home sales but prices that have been strong in recent years. Again, the NAR provides excellent data. Its release on prices in the third quarter, which appeared Nov. 14, says that "Most metropolitan areas continued to experience strong price gains during the third quarter, but with slightly fewer areas rising at double-digit rates."
The NAR found from its analysis of 123 metropolitan areas that in 29 of them, median existing-home prices had risen at double-digit annual rates in the third quarter and that prices had fallen in only four areas. In the second quarter, 35 metropolitan areas experienced double-digit annual price increases.
The highest annual price rises in the third quarter were in the Northeast. The NAR reports that "The strongest increase was in the Nassau-Suffolk area of New York, with a median price of $263,300, up 22.6 percent from the third quarter of 2000. Next came the Monmouth-Ocean area of New Jersey at $217,000, up 21.4 percent from the third quarter of 2000. Third was Worcester, Mass., where the third quarter median price of $163,600 rose 21.3 percent from a year earlier."
Nine months into the slowdown of the U.S. economy, which began in the fourth quarter of 2000, house prices in many areas are rising strongly. These are curious woods.
The continuing housing boom is strange indeed because housing is normally one of the first sectors of an economy that slows in a recession. But recessions normally occur when inflation rises and interest rates are increased. This time the slowdown did not begin with inflation; and interest rates, rather than rising, have been tumbling. Alan Greenspan's 450 basis point (4.5 percentage point) cuts in the short-term Fed Funds rate this year have not fed through to longer-term mortgage rates proportionately, but they have had an effect. The NAR's Web site reports data from Freddie Mac which shows that the average commitment rate on a 30-year conventional fixed-rate mortgage was 6.97 percent in the third quarter, down from 7.13 percent in the second quarter and 8.03 percent in the third quarter of 2000. A more recent weekly survey by Freddie Mac put the average new mortgage rate at just 6.45 percent, the lowest since Freddie Mac started tracking mortgage interest rates in 1971.
The continuing housing boom is rightly being pointed to as a prop for the U.S. economy. Revised GDP figures for the U.S. economy, released Friday, show that private investment in homes rose at an average annualized rate of 5.6 percent in the first three quarters of this year. In all three quarters of 2001 all other categories of private investment fell at double-digit annualized rates as businesses cut back spending. In an economy that contracted 1.1 percent in the third quarter, residential investment kept growing.
Housing has also been a part of the "wealth effect" in the U.S. economy: the support given to consumer confidence and therefore to spend by rising asset prices. Rising equity pries were the senior partner in the wealth effect; rising house prices the junior one. But in 1998 and 1999, according to Federal Reserve figures, the rise in house prices increased the net wealth of American households by $543.1 billion and $573.6 billion, respectively: These are amounts equivalent in each year to more than 5 percent of U.S. GDP. The rising value of U.S. stocks produced much greater paper wealth gains for households in those two years: of $1,229.6 billion and $2,358.7 billion, respectively. But while in 2000 equities lost value, reducing households' paper wealth, the house price boom went on, producing a further gain in household net worth from property of $986.8 billion, a sum equivalent to around one-tenth of U.S. GDP. And in 2001, the gain has continued: up by a further $408.8 billion in the first half of the year, according to the latest Fed figures.
Have seemingly more valuable house, will spend: That is the relationship. In the U.S. slowdown, as experienced so far, consumer spending has not fallen; it has kept growing: at an annualized rate of 1.1 percent in the third quarter, according to the revised GDP numbers released Friday morning. And the investment in a house is itself the biggest purchase of all, one, as we have said, that has helped, with all the spending that follows a house purchase, to keep the U.S. economy from sinking deeper into recession.
But buying a house also implies the taking on of more debt. Falling interest rates have meant that house buyers have kept borrowing, even as the economy turns down and unemployment has been rising. Thus, as the slowdown in the U.S. economy goes on, rather than becoming more defensive, rather than protecting themselves against unemployment, lower bonuses, lower incomes, Americans are exposing themselves more and more to debt, making themselves more and more vulnerable to adversity. And finance companies are sharing in this risk-taking, extending more and more credit even as the economy turns south.
It is a familiar story, one similar to that for the late 1990s U.S. stock market boom. The housing boom has spiralled out-of-control, fostered in part by the low interest rates that have been provoked by the distress of the rest of the economy. But just as with equities at the height of their boom, those with a hand in the market see boom going on and on.
The dangers are plain; there ought to be no lack of visibility here. Unless the U.S. economy rebounds quickly, unemployment and depressed earnings will mean more and more American households are going to struggle to handle their debt. And house prices are likely to fall, just as they did following their boom in the mid-1980s, perhaps heavily after three record-breaking years. The average house bought in Boston in the third quarter of 1987 sold for the same price seven years later. When inflation is taken into account, that represents a big capital loss.
Falling house prices would mean that the negative wealth effect from a stumbling stock market would no longer be offset by housing. Americans are going to feel poorer. They are going to save more and spend less. And that will provide the correction the economy needs, bringing down the trade deficit and the inflated stock market. This is the inevitable end of an asset price boom that got out of hand, a boom that has still not even ended in the housing market, and that the Fed's medicine is prolonging rather than bringing to an end.
What do these houses point to? Has our trail brought us to safety, or greater danger? In your correspondent's view, to greater danger. The extension of the housing boom is a bad thing, not a good one. It implies that America is getting itself deeper into debt, increasing the danger that slowdown will become slump. The U.S. slowdown and that of the world economy are just beginning, not ending. The path ahead does not lead to quick recovery but deeper into the woods.
(Global View is a weekly column in which our economics correspondent looks at issues of importance for the global economy. Comments to firstname.lastname@example.org.)