Burning Down the House?

Though Maxed Out Mama is the housing market expert, David Malpass, chief economist at Bear Stearns, says "Don't Panic" in the WSJ:

U.S. growth has endured other waves of equally loud pessimism -- over high gasoline prices, low (pre-revision) estimates of job growth, a supposedly negative personal savings rate (revised to positive on July 27 by the Commerce Department) and even the 2003 tax cut on labor and capital. Remember the argument that tax cuts would put the economy on a path toward fiscal collapse and recession? Now, the U.S. deficit is set to fall below $150 billion by Washington's September fiscal year-end, thanks to strong tax receipts.

While it's frowned upon to look for a silver lining when markets tumble and painful losses accumulate, the housing- and debt-market corrections will probably add to the length of the U.S. economic expansion. Overly low interest rates in 2004-2006 channeled economic activity into housing and debt financing. Corporate bond yields fell relative to Treasurys, causing leveraged investments. This artificial allocation of U.S. capital now looks like it will be corrected before inflation kicks in (CPI will likely top 4% later this year) and higher tax rates bite (the massive increase scheduled for 2011 when the Bush tax cuts expire).

The bearish view is that Americans live, breathe and spend their houses and mortgages. Yet the July 31 consumer confidence survey by the Conference Board jumped to 112, the highest in the six-year expansion. Data and theory show clearly that houses are not the be-all and end-all of the economy. Jobs matter more. For many, the value of future employment is much greater than their home equity. The low jobless claims and unemployment rate -- clear signs of a strong labor environment -- raise confidence and likely future wages. This outweighs changes in wealth, whether from declines in house prices or the stock market, especially for lower-income workers.

Neither the economy nor job growth has been dependent on housing. Residential construction declined to 4% of GDP in the second quarter -- right on the 1990s average -- having boomed excessively in 2004 and 2005 and subtracted heavily from GDP in 2006. But strength in commercial construction more than offset the weakness in residential construction, allowing overall construction to add to GDP for the first time in a year. . .

Nor has consumer spending been dependent on "cashing in" on the housing boom. The increase in mortgage equity withdrawals in 2004 and 2005 funded big net additions to household financial assets, while consumption growth remained steady. Mortgage equity withdrawals slumped throughout 2006, yet consumption growth was particularly fast in the fourth quarter of 2006 and the first quarter of 2007.

Why haven't swings in the mortgage market had much effect on consumption? Fed data shows that the surge in mortgage growth in 2004 and 2005 was accompanied by an equal surge in household additions to net financial assets. Inexpensive home financing helped households increase their Treasury and equity purchases, and their checking accounts, while slowing the growth in auto and credit card debt. Rather than hitting consumption, the 2006-2007 mortgage slowdown has caused these other household balance-sheet practices to return to normal.

In the long list of worries about consumption, the threat of mortgage-rate resets is providing the latest fixation. It shouldn't. Payments on some $500 billion of adjustable rate mortgages are scheduled to go up in 2007. If the mortgage rate is adjusted upward by an average two percentage points, that's $10 billion in added payments. To put this in perspective, wages for nonsupervisory workers increased by $296 billion over the last 12 months. The July 27 revision alone added $130 billion to the last year's total U.S. personal income, raising it to $11.5 trillion, reflecting the hard-to-track dynamism of the U.S. economy.

The constant warnings of a housing-related collapse in domestic consumption overstates the importance of housing in the economy, while understating the importance of jobs and economic growth, both of which have been solid. Of course, sellers of both houses and bonds would like more froth in their markets. But buyers, and likely the economy as a whole, will probably benefit over time from the wrenching return to more normal market conditions.