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Pain From U.S. Housing Slump Is Likely
To Linger, but Some Say Worst May Be Past

By JAMES R. HAGERTY
October 30, 2006; Page A2

Just when the gloomier pundits were starting to enjoy the housing slump, optimists are piping up to declare it could be almost over.

Former Federal Reserve Chairman Alan Greenspan, whose interest-rate cuts helped create what he once called "froth" in house prices, said in a speech last week that he detected "early signs of stabilization" in the housing market. Some Wall Street economists also are saying the worst may be behind us.

Not so fast, replies Ian Shepherdson, chief U.S. economist at High Frequency Economics Ltd., a Valhalla, N.Y., research firm: "It's going to get worse before it gets better."

Both camps are making valid points. The maximum impact of falling home construction may have hit the U.S. economy in the third quarter, some economists say. But that doesn't mean the housing market is on the verge of a miracle recovery. Construction is expected to fall further as builders struggle to shed a glut of unsold homes. And many economists expect house and condominium prices to continue falling for at least an additional six months to a year in parts of the nation where speculators went wild.

For now, the consensus among economists is that the housing downturn will remain a drag on the economy but probably won't sink the U.S. into a recession next year. Even Mr. Shepherdson, among the most bearish, believes the U.S. has a 60% chance of averting a recession in 2007. In any case, the weak housing market will remain painful for speculators who loaded up on credit to buy near the top -- and for millions of people working in housing-related industries. Just last week, Countrywide Financial, the U.S.'s largest mortgage lender, announced plans to shed about 2,500 jobs, or 4.5% of the company's total.

Largely because residential investment dropped at an annual rate of 17%, inflation-adjusted economic growth in the U.S. slowed to a feeble rate of 1.6% in the third quarter, according to an estimate released by the Commerce Department. Without that drop in residential building, economists said, the growth rate would have been about 2.7%.

After the third-quarter carnage, expect "some gradual improvement from here," says Peter Kretzmer, a senior economist at Bank of America in New York. He expects residential construction to decline at an annual rate of 13% in the current quarter, 5% in next year's first quarter and 2.2% in the second quarter before starting to grow again. Mr. Shepherdson disagrees, arguing that the drop in construction will accelerate before the market regains balance.

Offsetting the housing damage are several positives. Gasoline prices and mortgage interest rates have fallen in recent months. The stock-market rally has made some people feel richer, even as those who trust only in real estate feel poorer. And job growth, though unspectacular, continues at a "solid" pace, says Scott Anderson, an economist at Wells Fargo in Minneapolis.

With home prices flat to lower in much of the country, Americans already have less ability to tap their home equity to finance spending. But it is unclear how much effect that will have on consumer spending. Some economists believe that rising wages, the stock-market rally and lower energy costs will be enough to keep Americans loading their shopping carts with iPods and flat-screen TVs.

Mr. Greenspan sees hope in the rate of applications for home-purchase mortgages. After falling in the second half of 2005 and earlier this year, they have leveled off in recent weeks.

Some of the optimists' arguments are dubious. To bolster its position that the housing market is stabilizing, the National Association of Realtors last week trumpeted a 2.4% decline during September in the number of previously occupied homes offered for sale through multiple-listing services. But the Realtors' news release didn't mention that listings almost always decline in September, when the back-to-school season means fewer people are moving. Over the past 20 years, listings have declined an average of 3.4% in September, says Ivy Zelman, a Cleveland-based housing analyst for Credit Suisse.

Ms. Zelman, who last year correctly predicted a plunge in home-builder share prices, thinks investors who now are bidding those prices back up are way too early. Sales of new homes are unlikely to start rising again before early 2008, she says. Meanwhile, "land is going down in value daily," she says.

Joshua Shapiro, chief U.S. economist at research firm MFR in New York, is more upbeat but still thinks home prices will "stagnate" on a nationwide basis for several years, as rises in parts of the country are offset by continued declines elsewhere. After the unusually steep surge in home prices during the first half of this decade, he says, it will take time for incomes to catch up again with housing costs.

Write to James R. Hagerty at bob.hagerty@wsj.com

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