US housing market flashes warning on economy

One of the widely acknowledged risks to the global economy has been the global housing market. Thanks to low interest rates worldwide, this market has boomed over the past few years, boosting economic activity as well as fuelling consumer demand through home equity withdrawal. There are signs, however, that this boom may not last much longer.

While house prices had moderated earlier in places like the United Kingdom and Australia, the housing market in the United States, the main source of global demand, had seemed impervious to the slowdown. Until recently that is.

On Friday, the US Commerce Department reported that sales of new single-family homes in February were down 10.5 percent over that in January, the biggest fall since 1997. Median home prices fell as well -- the fourth consecutive month of decline -- hitting US$230,400 in February, the lowest level since July 2005.

While sales fell, the number of new homes available for sale rose 4.4 percent to an all-time high. At the current rate of sales, the number of new homes would take 6.3 months to sell, representing the longest period since January 1996. This inventory of new houses that has built up is likely to put downward pressure on house prices in the coming months.

In view of housing's role in influencing consumer demand, many economists fear that the weakening housing market is flashing a warning signal on the economy. They fear that the weakness in the housing market may be the prelude to a slowdown in consumer spending and a possible recession.


The chart above shows past downturns in consumer spending and recessions associated with declines in new home sales. As can be seen, recessions have often occurred when new home sales have declined sharply -- in the order of 20 percent or more on a year-on-year basis at the trough.

The last recession in the US was in 2001. However, that recession was not associated with a large decline in new home sales, and real consumer spending did not turn negative on a year-on-year basis.

The last time new home sales saw declines of around the magnitude seen in earlier recessions was in 1994-95. That decline, however, was not followed by a recession, and consumer spending stayed positive during that period as well.

The latest fall in new home sales is close to but has not quite hit the extent in 1994-95. Not yet at least. Since the US economy escaped a recession in 1994-95, it seems reasonable to argue that it is premature to conclude that the latest new home sales number indicates an impending recession.

One caveat though. Back in 1994-95, real estate assets held by households and non-profit organisations in the US totalled an amount equivalent to less than 117 percent of GDP. Today, it represents about 170 percent.

Clearly, a lot more is riding on housing this time around.