by Calculated Risk on 5/09/2006 02:15:00 PM

I've just read the Citigroup May 9th Consumer Update. To say Citigroup remains bullish on the US economy (and homebuilders too) is an understatement.

I must be missing the fun with the "recreational debt creation", but lets check a few numbers. Real residential construction grew 5.8% over the last year, from $584.1 Billion in Q1 2005 (annualized) to $618.2 Billion in Q1 2006 (in 2000 dollars). GDP grew 3.5% over the same period ($10.999 Trillion to $11,381.40 Trillion in 2000 dollars).

If residential construction had been flat, GDP would have been around 3.1%. So Citigroup's number is technically correct (less than 0.5 percentage points of GDP growth came from growth in residential construction), but that is still a substantial contribution to GDP growth.

And what if residential construction falls 10% this year (a common estimate)? All else being equal that would put real GDP growth at around 2.6%. And that is excluding any impact from the loss of the "wealth effect" and the loss of housing related employment.

It is true that personal interest income has been rising almost as fast as mortgage interest payments. The general idea is simple: as strapped homeowners reduce their personal consumption expenditures, other consumers will take up the slack with their additional interest income.

However, it seems likely that consumers receiving substantial interest income tend to save more - and as interest rates rise, the savings rate will increase - so its not a one for one substitution for consumption. Besides, the primary concern for housing is the marginal homeowner with an ARM. As rates rise, these homeowners might be forced to sell, increasing the supply of houses for sale and eventually putting pressure on prices - and reversing the wealth effect.

There is much more in the Citigroup report, but suffice to say Citigroup didn't convince me. I remain concerned about the impact of the housing slowdown on the general economy.