Why Housing Is the Key to the Recovery

Take a look at this table, showing the year over year change in the Case-Shiller Housing Index:

Housing is rebounding. It's clear as day. And not only prices, but construction. New home construction is up 42% in the last year. Homebuilder confidence is at the highest level in six years. 1.3 million fewer homes have an underwater mortgage today than did in the second quarter.

These trends could change, especially if Congress bungles the fiscal cliff. But if they hold, housing's rebound could be the key to real, legitimate recovery.

How do we know? Because housing was the overwhelming cause of the recession to begin with.

A Federal Reserve study last year found that the plunge in housing construction and the knock-on effects from industries it supports accounts for about half of all job losses since 2007. Another study earlier this year wrote that "more than half the underperformance in this recovery is associated with housing-related sectors."

The latter paper broke states up into two categories: Those where home prices fell a lot (Arizona, California, Florida, etc.), and those where home prices muddled though the recession without much decline. What it showed was important: States where housing collapsed are doing poorly, while states with declines were actually doing pretty well.

Remodeling permits in high-decline states were down more than a quarter since 2006. In low-decline states, they're up more than 20%. Auto sales in high-decline states declined 40% since 2006. In low-decline states, they were about flat.

Yet another study from last year looking at household debt accumulation -- most of which is mortgage debt -- showed the same thing. Regions with the lowest debt accumulation barely saw any dip in residential investment. Regions where it was the highest saw construction collapse by more than half. Auto sales in regions where debt accumulation was the highest during the boom were down 40% since 2005. In regions where debt accumulation was the lowest, auto sales were up 30%.

Same stuff for ZIP codes that have a high percentage of homes with underwater mortgages.

And as Warren Buffett wrote in this year's letter to Berkshire Hathaway (BRK.B -0.26%) shareholders: "I believe [housing] 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."

You get the point. All signs point to housing being responsible for the slow recovery.

But now housing is starting to rebound in a big way.

Five years ago, anyone who brought up the idea that the economy was headed for trouble was met with a chorus of heckles and claims that they were out of touch with reality. You couldn't blame them. It's natural to look back at the most recent handful of years and assume the coming handful will be about the same. People have a hard time anticipating change.

I think we're seeing something similar today, just in the other direction. Anytime someone brings up the possibility that the next few years will be stronger than the last few they are met with a chorus of heckles and claims that they are out of touch with reality. They look back at the last handful of years and expect the coming years to be about the same. It's only natural, but they'll likely be wrong.