Decline in housing not spreading – other sectors picking up the load

Last week Philadelphia Federal Reserve President Charles Plosser spoke on “House Prices and Monetary Policy” at the European Economics and Financial Centre in London. Focusing on his view of the economy, key points in his presentation were that the decline in housing prices has been overstated in the media, the decline in housing is not spreading to other sectors, and that other sectors are picking up the slack – even within the construction industry. Separately, his key point regarding monetary policy was that central banks should not base monetary policy on targeting asset prices – including for housing. Doing so would undermine a central bank’s credibility and confuse the public over what the central bank would be doing in regard to the main mission of maintaining overall price stability in the economy.

Housing price decline is overstated

One of the Philly Fed president’s key points is his view that the media has been overstating the weakness in housing prices. He argues that price weakness primarily varies significantly by city and that the media has focused on the sharp declines seen in selected metropolitan areas. He argues that three key housing price indexes indicate that the softening in housing prices has not been as dramatic as indicated by the media.

He finds that the quarterly index put out by the Office of Federal Housing Enterprise Oversight (OFHEO) has not even started to decline. For the first quarter of 2007, single-family home prices decelerated to a year-on-year increase of 3.0 percent – down from the recent peak of 10.9 percent in the second and third quarters of 2005. The latest number still shows prices not yet declining for the U.S. overall.

He sees that housing price weakness has varied significantly by locality. Local conditions are the key drivers for local prices – more so than national conditions. The metropolitan data from the OFHEO corroborate this insight. Looking over the past 4 quarters, some markets even remain red hot – such as Wenatchee, Washington which has a 25.6 percent appreciation rate from 2006 Q1 through 2007 Q1. 

In the other direction a number of metro areas are cooling off. Punta Gorda, Florida has lost 4.6 percent in home prices over the same time period. Plosser points out correctly that most of the metro areas with recently declining home prices are those that previously had a sharp run up in appreciation.

Two popular measures of housing prices, median sales prices for new and also for existing home sales, show declines but not at the rates often portrayed in the media for selected cities. From the Census Bureau’s report on new single-family home sales, the median U.S. price declined 0.9 percent on a year-on-year basis in May – up from down 9.5 percent in April. From the National Association of Realtor’s report on existing single-family home sales, the median U.S price slipped 2.4 percent in May on a year-on-year basis – down further from down 1.5 percent in April.

Other construction sectors are offsetting housing’s weakness

While housing has gotten most of the attention from the media in terms of what is going on in construction, the nonresidential and public sectors actually are doing quite well – another one of Plosser's key points. Construction outlay data confirm this. While private residential outlays were down 17.6 percent year-on-year in May 2007, private nonresidential outlays were up a robust 18.9 percent. Even public construction is up 11.3 percent over the same time frame.

Currently, private residential outlays make up almost half of total construction outlays – meaning that private nonresidential and public outlays combined are over half. Combined, private nonresidential and public outlays have the strength to offset the weakness in housing.

Construction employment is strong outside of residential

Many have pointed out that construction employment has been weak in recent months. But in contrast to past periods of weakness in housing, other sectors have been strong and have kept overall construction employment close to steady. As of June 2007, overall construction employment was down 0.1 percent on a year-on-year basis. Breaking out employment on buildings, the residential component was down 1.2 percent while the nonresidential component was up 0.1 percent. 

But construction employment for buildings is only part of the story. While specialty construction employment growth for residential construction has been weak, declining 4.4 percent in June year-on-year, growth has been healthy for nonresidential and in heavy & civil engineering. These latter two advanced 3.1 percent and 3.0 percent, respectively, for June. Construction employment for the nonresidential and public sectors clearly is offsetting declines in the residential component.

Other aspects of consumer wealth still providing support

Plosser points out that many of the worries about the consumer sector pulling back due to loss of home equity have been overdone. He argues that not only is home equity still growing for most home-owners but that stock market gains have added to consumer wealth in recent months. Flow of funds data from the Federal Reserve and stock prices confirm his point. The overall value of equities and mutual funds grew 8.8 percent in 2006. More recently, the Wilshire 5000 stock index – a broad measure of U.S. equities – advanced 6.7 percent over the first six months of 2007. Indeed, consumer wealth is continuing to rise despite softness in selected housing markets.

Going beyond pointing to moderate gains in market wealth, the Philly Fed president does end up casting a wide net for why the continuing decline in housing is not expected to pull down the rest of the economy. He notes that payroll employment growth has been strong, rising 1.7 percent in 2006 and with the unemployment rate remaining low at 4.5 percent. Workers have seen respectable pay gains with average hourly earnings up 4.1 percent in 2006. Corporate profits have been healthy and banks in general are in good shape although subprime lending issues are still a concern.

Bottom Line

The bottom line from Philadelphia Fed President Plosser is that housing’s impact on the economy has been overplayed by the media. The strength in nonresidential and public sectors of construction will continue to offset weakness in housing. The consumer sector still has substantial gains in wealth to support spending despite the slowing in housing appreciation. Essentially we can expect the economy to strengthen in coming quarters despite continued weakness in housing, and the consumer will still play a positive role in economic growth.