The Trouble with Housing
For state and local revenues to improve, housing sales need to improve. The problem is that the outlook for housing isn't very pretty.
No doubt about it: When housing booms, so do state and local economies. Economists have long held that housing is the industry that typically leads the nation out of recession. As housing is bought and sold, built and remodeled, local construction jobs are created, along with orders for refrigerators, carpeting, windows, screwdrivers, nails and flower pots. Income and sales taxes increase, home values rise, and, as a result, state and local revenues stabilize and grow.
In 2008, the bursting of the housing bubble and the toxicity of mortgage-backed securities helped bring the economy down. "Housing is the primary motivator for how we got into this recession," says Kim Rueben, a senior fellow at the Urban Institute-Brookings Tax Policy Center. "We overbuilt housing and made it too easy for people to borrow."
Unfortunately, industry forecasts still predict housing will continue, for the foreseeable future, to be a drag on the economy. David Crowe, chief economist at the National Association of Home Builders (NAHB), anticipates an anemic 580,000 housing starts for this year. Predictions for 2012 are barely better at 700,000, which is down 20 percent from an earlier forecast of 873,000. (In 2006, when the housing market was flying high, starts were robust at 1.8 million.)
How serious a drag is the housing depression for states and localities? I put that question to Doug Duncan, the chief economist for Fannie Mae; David Merriman, an economics professor and associate director of the Institute of Government Public Affairs at the University of Illinois at Chicago; and Tracy Turner, economics professor at Kansas State University. Their edited and condensed insights follow.
Doug Duncan: One of most striking current statistics I've seen is that, in the U.S., there are only 60,000 completed new homes available for sale. That is the lowest number since World War II -- and our population is something on the order of 2.5 times as large as it was then. The low number of finished new homes is simply a signal of decline in economic activity related to housing, which is a generator of revenue for state and local governments.
This is a very weak recovery, largely because housing is a drag on growth. Typically, in the first year of a recovery, averaging across all recessions since World War II, housing provides 18 percent of GDP growth. There's only one recession in which housing provided less than a double-digit contribution, and this current one would be the first where it is negative. Related to that is housing's contribution to employment. In that same first 12 months of expansion, usually about 10 percent of job growth is real-estate related. This also has been a very weak recovery in terms of employment, and that has a strong relationship to housing. The first thing to look at to understand housing is employment. Employment generates income growth and household formation, which creates demand for housing whether rental or owner-occupied. Today, we're in a position where only about half of the metropolitan areas are adding any jobs and that's very weak. Unemployment is hovering around 9 percent. Construction of real estate is a significant income generator in most markets, and that has implications for income tax revenue and business tax revenues.
There also have been a lot of layoffs of state and local employees. Those folks may have houses and that may cause financial difficulties. Some markets may be more heavily impacted by that than others, especially in state capitals where there's a concentration of those employees. Many of the layoffs have been in public schools, fire departments and police, and those layoffs are spread throughout a state.
David Merriman: Housing is holding back the economy in a number of ways that are important to state and local government. To the extent the economy is performing poorly has to do with people's confidence. They don't think their houses are worth what they paid for them. Values are low. People are conservative about spending and that creates difficulties in terms of employment and investment. They are not willing to invest in houses or upkeep, and that is also true on the commercial side. Businesses are reluctant to invest or expand, so a recovery in housing is key to an economic recovery.
Tracy Turner: This is the largest housing bust since the Great Depression. When people are deep in negative equity, as many are now, they don't spend. Studies show that on average, for every $1 decline in house value, a homeowner spends 6 cents less in the community. That takes a toll on the sales tax and on general economic activity.
Housing led us out of the 2001 recession because interest rates were low and housing prices didn't take a big hit. In terms of a housing market expansion, [Paul] Krugman [a New York Times columnist and the Nobel-prize winning professor of economics at Princeton] likes to say we made a living in the early 2000s by selling each other houses.
I don't think we can say housing will lead us out this time. But people have to be doing okay in the housing market in order for us to get out of it at all. The future is uncertain, so I wouldn't rely on housing to lead us out of this recession.