Some Economists Predict Bubble Will Burst, Recession Will Follow

While most of the United States has enjoyed a remarkable real estate boom for the past five years, all signs point to the raging, money-making party being over. But have prices simply plateaued, or will the bursting of the bubble trigger greater economic problems? A number of high-profile firms are forecasting the latter.

The Center for Economic and Policy Research predicts in a July report that the “collapse of the housing bubble will throw the economy into a recession, and likely a severe recession.” A recent report by the financial firm Lehman Brothers concurred, stating that “a turn in the housing market is central to our economic forecast.” Merrill Lynch economist David Rosenberg said recently that he believes “the demographic story behind the housing market boom, as we always thought, was a giant hoax.”

Gulp.

What the actual fallout will be remains to be seen, but if housing prices decline as sharply as predicted, there is little doubt the effects could be broad. Lehman Brothers estimates that about one-third of the past year’s economic growth was because of the housing boom, with construction equal to 5 percent of the U.S. economy. Goldman Sachs predicts that a downturn in housing could lead to the loss of 1.3 million jobs, raising the national unemployment rate by 1 percent overall and by as much as 2 percent in areas such as California.

Considering the job cuts in housing-dependent businesses, such as banking, furniture and building materials, some analysts predicts worse, saying the inevitable bubble burst will mean the loss of 5 million to 6.3 million jobs. Worse yet, a federal bailout of the mortgage market is likely if housing crashes, the Center for Economic and Policy Research predicts. Henceforth, if corporate funds continue to struggle and these scenarios materialize, the government could conceivably hold your mortgage and pension.

This is still just speculation as far as the long-term economic damage and how wide-ranging the consequences will be. However, it is widely accepted that housing prices will decline. Mark Zandi, chief economist at Economy.com, an independent provider of financial research, points to the simple fact that if mortgage rates rise slowly (as they have been), housing prices will ease gradually. There is also the matter of simple supply and demand — which currently looks very much out of whack as far as housing is concerned.

• For six consecutive months, ending in September 2005, home builders started work on more than 2 million new properties.
• That amount of contruction has only happened three other times in the postwar period, according to Merrill Lynch: 1971-1972, 1977-1978 and early 1984.
• Those periods were different from today in at least one respect — more people were forming households. Household formation is defined as the growth rate in the number of households, and is boosted by new immigration and twenty-somethings leaving their parents’ homes. It is currently half what it was for most of those peak periods.

Another reliable indicator, unsold homes on the market, also points to a price decline. The ratio of available inventory to sales has been rising rapidly and stands at its highest level since 1996. Rents provide more evidence of a supply-and-demand imbalance. Sale prices for homes have generally kept pace with the national inflation rates, with rents fluctuating at the same pace, but the Center for Economic and Policy Research says this has not been the case in roughly eight years.

What does this mean for you locally? Does this mean you should avoid Florida real estate altogether? Should you horde your money for 10 years and wait for the dust to settle? Not necessarily. If prices drop, it may actually benefit first-time buyers who are looking at their property as a long-term investment. Be cautious, however, for the projected, precipitous decline in prices means that many homes are still drastically overvalued. Don’t buy expecting a quick return, and don’t jump on any deal without thorough market research.