Housing: hiccup or hurricane?

Economists fathom the depths of the current downturn

Depending on whom you talk to, the housing market slowdown will have slight to far-reaching effects on the state’s finally reawakening economy. Some economists say the decline in home prices and sales - the steepest in more than a decade during July - are part of a soft and necessary correction. They say it won’t curtail recent gains in the state’s high-tech and business service segments.

Others warn the housing slide is the start of a painful process that will be a drag on the state’s fragile economic momentum of recent months. But they stop short of expecting it to nudge us into recession.

We are, he says, in the midst of a "painful, soft landing," in contrast to the highest appreciation of home values in the state’s history between 2003 and 2005. "When you’re at the top of the mountain, the next step has to be down," he says.

Analysts assessing how far a step down the housing market and the economy will take are wary of a wild card. There’s no precedent by which to gauge how the greatly expanded mortgage financing market – in which many less-qualified homebuyers tapped into interest-only or option adjustable rate mortgages – will play out as the market cools.

Interpretations of the housing-market tea leaves vary, but most are still expecting a somewhat soft landing. They expect nothing like the drastic collapse of the late 1980s/early 1990s in which housing prices plunged some 12 percent. Not surprisingly, Guy Webb of the Worcester-based Builders Association of Central Mass. joins Waluka in the soft-landing camp. He says members began noting a slowdown in construction demand last spring and are curtailing their building plans, but not halting them. The housing market, he reminds, is still at record highs even though it doesn’t feel that way. And with positive state economic growth and still reasonable interest rates, Webb adds, "I don’t think the housing market can tank."

Among builders planning for a slowdown is Len Gengel, president of Rutland-based C & S Builders Inc. Gengel says he began to see demand drop in the summer of 2005 and turn very slow this June and July, with a rebound in sales in August. But, he says, after 14 years of unprecedented growth, the housing market needs to cool down. Gengel is planning on building a total of 14 homes in 2006, down from 17 last year. He slates 12 for 2007. C & S has been offering incentives to stimulate buyer interest, including free air conditioners this summer and plasma TVs last spring. Currently, it is supplying a free tank of oil with each sale.

Several local economists are leaning toward the soft-landing prediction as well, expecting modest decreases in housing prices and a moderate impact on real-estate-related jobs. Where they differ is in sizing up how the slowdown will affect the state’s overall economy.

Alan Clayton-Matthews, professor of public policy at the University of Massachusetts-Boston and co-editor of Mass Benchmarks, a quarterly publication on the economy published by UMass’ Donahue Institute, doesn’t expect the correction to stop a recent growth trend in the state’s economy. Benchmarks reported a 3.9 percent economic growth in Mass. in the second quarter of 2006, overcoming gloomy predictions early in the year that the state would continue its anemic pace trailing the national economic expansion.

Now Clayton-Matthews says he wouldn’t be surprised if the state’s economy continues to grow at a stronger rate than the nation over the next year and maybe over the next several years, despite the housing slowdown. For one thing, he notes, the rest of the nation is also facing a housing market deceleration. Housing prices will likely continue to fall through the end of the year, Clayton-Matthews predicts, slowing construction and consumer spending.

Karl Case, professor of economics at Wellesley College, and Barry Bluestone, dean of the School of Social Science, Urban Affairs and Public Policy at Northeastern University, find that outlook a bit too rosy. Both say the housing slowdown will put a damper on the construction industry, which will slow the state’s already tepid growth.

Bluestone expects a possible 3-4 percent housing price decline and a likelihood that prices will stabilize over the next four and five years. He does see some potential for growth in some industry segments in the state but joins Case in noting that we are still 150,000 jobs behind making up for what we lost in the last downturn.

Case says it’s difficult to say how much of a drag housing will have on the state’s economic rebound, which he terms "very fragile." He is "hopeful that we won’t have a recession."

Construction, Case points out, employs 7.5 million nationwide and 143,000 in Massachusetts, about 4.5 percent of Bay State jobs. Add to that real estate brokers, lenders, lawyers and other real estate segments, he says, and the slowdown will impact as much as 20 percent of the U.S. economy. In the last significant housing downturn, construction employment dropped in Mass. to 65,000 to 70,000, Case says. But he doesn’t think those economic segments will take a "catastrophic" hit this time around.

Mark Zandi, chief economist for Moody’s Ecomony.com, also thinks the housing downturn will weigh heavily on the state’s economy, which he describes as seeing "sturdy, solid growth." Growth will slow to "just a bit uncomfortable," he says, predicting housing will "take the economy down a whole level over the next six to nine months." That will include a housing price decline of up to 5 percent statewide, Zandi says, with a 5-10 percent drop in the Boston area. He terms it a "tough landing" but not nearly as severe as the late 1980s when the job market was much worse here.

Economist point out that the real estate market has played a historically stronger role in sustaining the economy in Mass. and nationwide over the past half a dozen years. Nationally, the real estate market has created $10 trillion in new assets since the year 2000, according to Case. And the real estate market didn’t follow the economic slump of 2001 but served instead as a sustaining force as rising home prices buoyed consumer spending.

Bracing for a credit hurricane

The reason housing prices rose and the market flourished during the last recession was due to an historic change in the mortgage financing market. Economist Frederick Breimyer, member of the New England Economic Partnership, says mortgages used to be linked to the conservative realm of bank financing. In recent years, however, the source for mortgage money has broadened due to pooling mortgages for sale to investors, expansion of government agencies that do mortgage financing, an increase in foreign investors in real estate and an array of new mortgage options for consumers.

The resulting low interest rates allowed consumers to support spending and buoyed the region’s economy through the recession that span 2001 nationally but plagued Massachusetts through early 2003. But that trend is reversing itself. And Breimyer and other economists wonder what will happen if the poorer quality mortgages of recent years turn sour. "The jury is still out on this," Breimyer says, but notes he does expect credit fallout. "This will be our hurricane."

What’s more, Breimyer says, such finance "innovations" have saturated the mortgage market, leaving no new pool of mortgage customers.

On the growth side, he says, the state is showing some signs of recovery but still isn’t at a rate "most people are comfortable with." Bay State growth over the last 12 months is still well below the national average, according to Breimyer, and is 3.46 percent below its previous peak payroll level. On the other hand, he says, the state doesn’t need as much growth since it isn’t experiencing the population growth.

Breimyer says he doesn’t think the state is going into recession but predicts it won’t be able to build momentum and "may even have some slippage" in its economic growth beginning the second half of this year. Unless there is an energy price escalation, he expects a significant housing price decline for the next two years. Breimyer says this correction will probably "rival but not meet" the early 1990s, terming it a "hard landing - but it will be a landing."

There is a silver lining to the housing market slowdown, say economists and those in construction and real estate. The correction was long overdue and will check runaway home prices and weed out poorer quality builders. Some say it could even help the state with its nagging housing affordability problem. But only to a limited degree.

Clayton-Matthews says if housing prices continue to drop for another year while income continues to grow in the state, it "will go a long way to improving affordability of houses." Breimyer agrees it will be a "small step" toward housing-price relief and adds it may also inspire homebuilders to build smaller and smarter.

But, he adds, since the market is adjusting nationally as well, housing costs in Mass. will remain on the high side. "People aren’t going to be flocking here because it suddenly looks cheap," Breimyer says.

Micky Baca can be reached at mbaca@wbjournal.com