Housing Is Key to Recovery

10/21/2010 12:00 pm EST

Focus: MARKETS

Knight Kiplinger

Editor-in-Chief, The Kiplinger Letter, Kiplinger's Personal Finance, and Kiplinger.com

Knight Kiplinger, editor-in-chief of the Kiplinger Letter, says the overhang of foreclosed homes and under water mortgages is a real drag on the economy, and could scuttle the recovery.

The key to avoiding a return to recession: housing prices.

If between now and spring, they decline only a small amount, the recovery will continue. If they lose about 10% on average—and the odds of that aren’t too long—gross domestic product will shrink. We expect prices to retreat by 3% or so, giving back some of the gain from earlier this year.

But the situation is particularly delicate. The fact is, the economy is stuck in a loop: The sluggish GDP pace means too few jobs are being created to boost demand for housing and to prevent further foreclosures, now caused more by lost jobs than by loans to unqualified borrowers.

Although private employers continue to slowly add to job numbers, state and local governments are now starting to pare their payrolls, shedding 83,000 workers in September. This latest trend, along with the subpar private employment growth, is worrisome, but it doesn’t necessarily spell a return to recession, merely a lengthier convalescence.

So, the supply of homes continues to grow, and prices to slide. That, in turn, acts as a drag on consumer spending, muting economic growth.

How big is the excess? At least one million—and maybe as many as four million homes.

As the economy finally starts to perk up a bit in 2011, about 1.5 million additional US jobs will be created. Home sales and building starts will improve.

But the overhang will take years to play out. Next year, starts will likely run at about 700,000. Though an improvement over this year’s 600,000, it’s less than half of the average annual tally between 1985 and 2005. As a result, residential building and industries associated with it won’t contribute to GDP growth for a couple of years.

Homeownership has dropped from 69.2% of households in 2004 to 66.9%, resulting in 2.5 million fewer homeowners than if the rate had remained steady.

There’s no shortage of ideas to help--but none that offer a real solution.

With about 25% of mortgage holders under water, owing more than their homes are worth, about five million households are in or will soon enter foreclosure status. Slashing mortgage balances would help, but it’s a political nonstarter.

Congress would have to find a way to spread the financial hit among taxpayers, banks, and mortgage debt investors. In today’s heated political climate, no chance.

Limited moratoriums in particular areas might actually help a bit in the short term by curbing the number of distressed homes put up for sale.

But if the mess spurs a nationwide freeze lasting into 2011, prices will dive as renewed uncertainty about the economy and home price trends forestalls sales.

In both cases, the process of balancing supply and demand will be prolonged. The only sure cure is time. The question is how painful the interim will be.

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