by Calculated Risk on 9/21/2006 02:50:00 PM

Economist Richard Berner believes the housing bust will have less of an impact on the economy than many observers expect. From Berner:

US housing activity is in recession and home prices are decelerating sharply, and those trends likely will intensify. The combination could pare as much as 1½ percentage points from US growth in the second half of 2006, and many are thus concluding that the economy is headed for trouble. We continue to think that there are significant offsets to these drags on economic activity, such as stronger global growth and declining energy quotes. As a result, the prognosis for growth could be stronger than either pessimists or market participants expect (see "Is This What A Soft Landing Feels Like?" Global Economic Forum, September 5, 2006). [emphasis added]

Berner comments on the weakness in the housing market, but he believes real prices will not fall significantly:

We’re bearish on housing activity and think the deceleration in prices has further to go. ...

The pessimists argue that the bursting of a putative housing bubble means that prices could decline significantly. There is some risk that prices could decelerate faster or even decline in real terms — after all, investment and speculative activity has picked up in the past five years. But the character of housing demand makes the much-feared decline in prices on a nationwide basis unlikely ...

Nonetheless, prices may fall in markets that are affected by a weak economy (e.g., Detroit), by high speculative activity (e.g., some condominium markets) or where there is a preponderance of second homes (e.g., in Florida or the Sunbelt). ...

However, the recession in housing activity is a nationwide development and will significantly depress growth. We estimate that the decline in 1-family housing starts directly will cut 0.9 percentage point from US real growth in the second half of 2006 (single-family construction amounts to about 3.3% of GDP; we expect that apartment construction will improve somewhat after eight years of no growth, which has limited supply and helped rents to firm). The plunge in single-family housing construction will cost both output and jobs. We expect that the loss of jobs in residential construction, real estate brokerage, and mortgage finance could amount to 10,000 monthly. ...

Of course, that’s not all. The decline in housing demand probably will crimp spending on furniture, appliances and other household goods ... A 10% decline in such outlays over a year could knock another 0.3% off overall GDP.

That may sound bearish, but Berner is painting a soft landing picture. Berner then addresses mortgage equity extraction and he believes the concerns are overblown:

...it would be reasonable to think that the surge in housing wealth and home equity extraction has fueled significant spending gains in these discretionary items, that households can postpone such purchases, and that even a deceleration in housing wealth could promote declines in these big-ticket outlays.

Reasonable, yes, but not entirely accurate. First, housing activity and big-ticket housing-related durables don’t necessarily march in lockstep anymore. ...

Moreover, and most important, in my view the deceleration in housing wealth will have at most one-fifth the impact on consumer spending that some fear. Some, including former Fed Chairman Greenspan, believe that 50 cents of every additional dollar of home equity extraction has financed consumer outlays. Empirical studies, however, suggest that a $1 decline in real housing wealth would trim spending by at most 11 cents, and some suggest that the effect would be half that magnitude (see “Housing Wealth and Consumer Spending” and “Housing, Mortgages and Consumption: Comparing Australia, the UK and the US,” Global Economic Forum, October 7, 2005 and March 2, 2006, respectively). Of course, that’s not negligible; we estimate that the flattening in real housing wealth in our outlook will pare roughly ½ percentage point from the growth in consumer outlays over the coming year.

This is a soft landing scenario.

I disagree with Berner on several points. I think real prices will fall nationwide, both in nominal and real terms. This is an important difference: first, I believe the psychological impact of falling prices will exacerbate the housing bust, and second, falling prices will have a larger impact on borrowers that have used nontraditional loans as affordability products (Berner didn't address the exotic loan issue). I will address Berner's comments on the impact of mortgage extraction in another post.