FYI: expect sharp recession after real-estate bubble bursts

Economists expect sharp recession after real-estate bubble bursts


NEW YORK ? Much of the nation has had a lovely real estate boom for
the past five years, but the house party is almost over and the
cleanup won't be pretty.

That's the word from economists and investors who have watched housing
prices march ever higher.

"The collapse of the housing bubble will throw the economy into a
recession, and quite likely a severe recession," warned a July report
by the Center for Economic and Policy Research.

In recent weeks, many major investment firms have concurred. Said a
Lehman Brothers report, "[A] turn in the housing market is central to
our economic forecast. "

"The demographic story behind the housing market boom, as we always
thought, was a giant hoax," wrote Merrill Lynch & Co.'s North American
economist, David Rosenberg, in a recent report.

If housing prices decline sharply, the effects could be broad. Lehman
estimates one-third of the past year's U.S. economic growth was a
consequence of the housing boom. Housing construction is equal to 5
percent of the national economy.

A downturn in housing could mean more than 1.3 million lost jobs,
Goldman Sachs Group Inc. predicts, bumping up the national
unemployment rate by 1 percent and the unemployment rate in house-mad
California by 2 percent. Those numbers don't include likely job cuts
in housing-dependent businesses, such as banking, furniture and
building materials.

The Center for Economic and Policy Research predicts worse, saying a
bubble burst would mean the loss of 5 million to 6.3 million jobs.

The housing run-up has financed consumer spending, creating more than
$5 trillion in bubble wealth, the center estimates. Consumers have
used "cash-out" mortgages to pay for everything from new kitchens to
college tuition.

A final nightmare scenario: A federal bailout of the mortgage market
is likely if housing crashes, the center predicts. So, if corporate
pension funds continue to falter and this dire prediction does come
true, the Feds could conceivably be holding your mortgage and your
pension.

While there's disagreement on what a downturn will mean, it's widely
held that a number of factors could bring prices down. A decline in
prices will track interest rates: If rates go up sharply, prices will
plummet, said Mark Zandi, chief economist at Economy.com, an
independent provider of financial research. If rates rise slowly,
housing prices may ease gradually.

Others point to simple supply and demand. Bubbles have their own
psychology -- a neighbor tells you at a party that her house has
tripled in value and you feel like an idiot for renting -- but supply
and demand operates on logic, which has to kick in at some point.

The supply and demand picture for housing looks out of whack. For six
straight months, ending in September, builders started work on more
than 2 million new homes. This has only happened three other times in
the postwar period, according to Merrill Lynch: 1971 to 1973, 1977 to
1978 and early 1984.

Those periods were fundamentally different from today in at least one
respect: More people were forming households. Household formation is
the growth rate in the number of households and it's boosted by new
immigration and twenty-somethings leaving their parents' homes. It is
currently half what it was for most of those peak periods.

"At no time in the past three decades has the gap between household
formation and housing starts been as wide as it has been over the past
12 to 24 months," Rosenberg wrote. "We've become accustomed to hearing
about how housing is in a new paradigm, that the fundamentals are
sound, so on and so forth. But please, just don't tell me that the
sector has managed to divorce itself from supply and demand
realities."

Another indicator, unsold homes on the market, also points down. The
ratio of inventories to sales has been rising rapidly in recent months
and stands at its highest level since 1996, according to Wachovia
Corp.

Rents provide more evidence of an imbalance between supply and demand.
Since World War II ended, sale prices for homes have generally kept
pace with the overall rate of inflation, and rents moved at the same
pace. That hasn't been the case for the last eight years, according to
the Center for Economic and Policy Research.