Rate Hikes Won't Cause a Housing Crash
We disagree with the persistent argument that the U.S. housing market is fragile and that the economy's growth is dependent on continued low interest rates. We expect a durable, relatively steady U.S. expansion into 2006. Katrina will slow third quarter GDP, but should add to fourth quarter GDP. Interest rates will probably rise substantially from here. This won't be good for the housing boom, but we don't think it will cause a substantial slowdown in the economy or in housing. We maintain our view that housing, while frothy, is not a fragile factor in the economy, though it may experience periodic local slowdowns and is distorted by tax policy and low interest rates.
Some observations:
- By destroying homes, Katrina and the flooding should add to new home construction and, with the related increase in construction costs, to the price of many new and existing homes.
- The median price of a U.S. home has increased sharply, but not out of line with increases taking place in other countries.
- Since March 2001, the beginning of the last recession, roughly> 44% of job growth has been in real estate, residential construction and credit intermediation (19% if measured from the end of the recession). This lifted their share in total payroll employment to 4% from 3.5% and gives rise to the contention that a slowdown in residential construction would necessarily slow the whole economy. More likely, job creation would shift to other parts of the economy if the pressure for residential construction eased.
- As a percentage of GDP, construction (residential and non-residential) is well below pre-1990 levels.
- Residential construction has increased its share of GDP, but non-residential investment has declined. The economy grew 3.6% in the year ending June 2005. Of that, residential investment contributed 0.34%, roughly 10%, of the growth.
- In the second quarter of 2005, approximately 5% of the economy's GDP was residential investment, up from the 1990s but in line with prior decades and the needs of the baby boom echo. Part of the strength in residential investment owes to the growth in the rate of formation of households headed by people 29 and under (i.e. those likely to need housing). 343,000 such households were created during 2003.
- The dollar value of new home sales has increased faster than GDP. This reflects record new home sales, the expansion in the size of new homes, and also the increase in the value of U.S. land (a positive side-effect of a long, healthy reflationary expansion.)