The loudest debate in financial circles these days is why the recovery is so slow.
It's also one of the easiest to answer: We had a housing bubble. It burst. The end.
A Federal Reserve study last year concluded that the plunge in housing construction and the knock-on effects from the industries it supports is responsible for about half of all jobs lost since 2007. A new paper (PDF file, Adobe Acrobat required) by a group of private economists looked at housing's impact on the recovery and found about the same. "More than half the underperformance in this recovery is associated with housing-related sectors," they wrote.
About that underperformance: Ten quarters after the end of most recessions, gross domestic product rebounds an average of 11.5%. After a deep recession, the average recovery is 13.4%. Since our latest recession officially ended in 2009, GDP has increased just 6.2%.
Of that shortfall, the authors found that more than half is directly tied to four sectors either entirely or mostly driven by housing: residential investment, housing services, local governments (influenced heavily by property taxes), and consumer durables.
It usually doesn't work this way. Ten quarters after most deep recessions, residential investment rebounds over 60%. This time around, it's declined. Housing services usually jump 7%. This time, they've inched up 1%. Local governments usually rebound 4%. Since 2009, they've declined over 5%. "In every previous post-war business cycle," the authors write, "home construction has had a V-shaped collapse and recovery; by contrast, the current cycle looks L-shaped."
It comes down to this: After most recessions, consumers buy homes and furnish those homes, causing consumption -- and debt -- to rise. Since this recession was caused by too much debt, and consumers have been getting rid of that debt, household liabilities are falling. Plunging, actually:
Sources: Federal Reserve and author's calculations.
This is good long-term. Deleveraging makes consumers more stable, and washes away the sickness that caused the recession in the first place. But in the short term, it makes the recovery menacingly slow. Money that used to be spent on goods that stimulated the economy is now used to pay off debt, and money banks once used to make more loans is now used to cover losses on defaulted debt.
Now here's where the report gets interesting. The authors broke up states into two categories: Those where home prices suffered a high decline (Arizona, California, Florida, etc.), and those where home prices escaped with a fairly low decline (Alaska, North Dakota, Texas, etc.). Then they looked at how each has fared over the last few years.
The results were unmistakable. States where housing collapsed are doing miserably, while states where declines were moderate are doing well.
Remodeling permits in high-decline states are down over a quarter since 2006. In low-decline states, they're up over 20%. Auto sales in high-decline states are down roughly 40% since 2006. In low-decline states, they're off a mere 10%.
Another study from last year looking at debt accumulation showed the same thing. Auto sales in regions where debt accumulation was the highest during the boom are down 40% since 2005. In regions where debt accumulation was the lowest, auto sales are up 30%. Same for housing investment. Regions with the lowest debt accumulation have barely seen any dip in residential investment. Regions where it was the highest have seen construction plunge as much as 60%.
Since the vast majority of household debt is in the form of mortgages, you can connect the dots: When wondering why the recovery is so slow, all fingers point to housing.
So what happens next? It's impossible to time when housing might actually turn around, but there are signs that a meaningful rebound isn't far off. After hitting a 50-year low in 2009, housing starts are rebounding virtually every month, are now up 46% from the bottom, and are expected to rise another 15% this year. As Warren Buffett wrote in his latest letter to Berkshire Hathaway
This hugely important sector of the economy, which includes not only construction but everything that feeds off of it, remains in a depression of its own. I believe this is the major reason a recovery in employment has so severely lagged the steady and substantial comeback we have seen in almost all other sectors of our economy.
Fortunately, demographics and our market system will restore the needed balance [between supply and demand] -- probably before long. When that day comes, we will again build one million or more residential units annually. I believe pundits will be surprised at how far unemployment drops once that happens. They will then reawake to what has been true since 1776: America's best days lie ahead.
Do you think he's right? Let me know in the comments section below.
