by Calculated Risk on 10/22/2006 11:17:00 PM

Dr. Altig provides us with excerpts from the latest Goldman Sachs newsletter:

"The sharp downturn of the past year seems to have brought total housing starts single-family starts, multi-family starts, and mobile home shipments close to the level justified by the underlying demographics (as best we can measure them)."

I agree with this assessment. My calculations also show starts have fallen to the "level justified by the underlying demographics" ... before subtracting the impact of recent overbuilding. So the next step is to account for the recent overbuilding, and that shows a further substantial fall in starts over the next year.

More from Goldman Sachs:

"Still, the fact that the US economy has bent but not broken during the fiercest onslaught of the housing downturn is encouraging. It suggests that real GDP growth probably bottomed for the cycle at the 1% (annualized) pace that we now estimate for the third quarter of 2006. While the headwinds from the direct and indirect effects of the housing bust will remain substantial, a sequential pickup in real GDP growth is now likely."

This assessment baffles me. What impact from the housing bust did they expect on the general economy? Yes, the decline in residential investment was a drag on GDP - and will continue to be a drag as residential investment continues to fall. But the significant impact of the housing bust will come from housing related job losses, the loss of mortgage equity extraction (used for consumption) and any financial distress associated with falling housing prices and tighter lending standards.

There is a significant lag between when a housing boom ends, to when housing related employment starts to decline precipitously. As Dr. Thornberg noted (talking about California, but applies everywhere):

"We have seen some losses in jobs in construction, maybe 20,000 over the last eight months or so, but that's not the full extent of it," said Christopher Thornberg, an economist at Beacon Economics, a consulting firm in Los Angeles. "The construction industry is really due to get clobbered; they basically broke even this month."

Click on graph for larger image.

This graph shows starts, completions and residential construction employment. (starts are shifted 6 months into the future). Completions and residential construction employment are highly correlated, and Completions lag Starts by about 6 months.

Based on historical correlations, it is reasonable to expect Completions and residential construction employment to follow Starts "off the cliff". This would indicate the loss of 300K to 400K residential construction employment jobs over the next 6 months. That will be a substantial drag on the U.S. economy.

Note: based on the current level of New Home sales, there are about 600K BLS reported construction jobs that will be lost over the next couple of years.

The second graph shows quarterly mortgage equity withdrawal (MEW) as a percent of GDP for the last 30 years. There is substantial quarterly variability in MEW, but it appears MEW has fallen, as a percent of GDP, from the levels of the last few years.

However recent data from the Mortgage Bankers Association (MBA) shows a rise in refinancing activity in Q3 2006, so MEW might have increased again in Q3. Also MEW related consumption probably occurs over several quarters following the extraction from equity. This means the economy is still probably receiving a boost from the record levels of MEW in late 2005.

As housing prices stabilize (and start to fall), MEW will decline and impact consumption. Although retail sales were sluggish in Q3, the impact from less equity extraction on consumption is probably just beginning.

Factor in tighter lending standards, the psychological impact of falling housing prices, rapidly rising foreclosures, and I think the impact of the bust has just started.