US Housing Market in 2006: The Economist's Take

The Economist's annual publication, The World in, looks to the year ahead for the political, business, and social trends worth watching. Here is an excerpt from The World in 2006 (unfortunately, the full article is available to subscribers only):

For the past few years America's economy has consistently defied those who predicted doom. That resilience has much to do with American Consumers' seemingly indefatigable appetite for spending. Year after year they have shrugged off shocks--from the bursting of the stockmarket bubble to soaring fuel prices--and kept their wallets open. The main reason is well known. Low interest rates have fuelled a house-price bonanza against which Americans have been able to borrow more and save ever less.

That combination cannot continue indefinitely. And the chances are that the turning-point will come in 2006. Consumers will be battered from three sides in the year ahead: the cost of fuel will stay high, house prices will flatten and even fall in some regions, and inflation jitters will push interest rates up.

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In the spring of 2005 the price of a typical house was more than 13% higher than a year earlier, the fastest pace of house-price inflation in over a quarter of a century. Over 80% of the increase in mortgage debt over the past couple of years has been due to households cashing out equity from their houses. After declining inexorably in recent years, the household saving rate turned negative in July.

But there are signs that this frothiness may be fading and that consumers are becoming more worried. Houses in many parts of the country are too expensive for many purchasers. The ratio of median mortgage payments to median income--a good gauge of affordability--is at its highest level since 1989, when the American property market last peaked. Inventories of unsold homes are rising and mortgage applications are slowing. Measures of consumer confidence plunged in September.

[...]

If house prices merely flatten, consumer spending will be hit. If they fall, it could be hit hard. And the effects of a housing slowdown would ripple further, slowing residential investment and hitting employment. Thanks to the boom in construction, residential investment now counts for 6% of GDP, its largest share since 1955. All told, around four out of ten jobs created in the past couple years are related to the housing boom. The lesson of other countries that have seen their property markets cool, such as Australia and Britain, is that the impact on consumption can be pretty dramatic.

The Economist's unapologetically bold demeanor means that their yearly soothsaying is frequently wrong (or the timing is badly off), but it's always an interesting read. You can get a taste from The World in homepage, where a few articles are available for free.