This Slowdown We Can Handle
by Lawrence Yun, NAR Chief Economist


The economy is slowing. In the fourth quarter, GDP growth will have shrunk for the first time since the 2001 recession. The projected decline is only 0.4 percent, but it is nonetheless a decline. Because of the lag time in data collection, economic shrinkage will be reported in late January. At that point there will be shouts of RECESSION, RECESSION, and RECESSION. Beware of DoomsdayersNo worries though. Technically an economic recession comprises two consecutive quarters of contraction. (It is measured that way because only a sustained economic contraction leads to sustained net job cuts.) The projected fourth quarter decline is due to cutbacks in residential construction activity and from a statistical “quirk” in business inventory investment. The business inventory components generally regain quickly. The inventory-to-sales ratio is touching record lows (i.e., companies are operating with thin inventory) and some build-up in business inventory is inevitable going into 2008. The cutbacks in residential construction are continuing but most of the major declines have already occurred. Subsequent construction declines in 2008 will have less of an impact. Housing starts have fallen from their 1.5 million unit pace in the early part of 2007 to 1.2 million in the latter part of 2007. For 2008, housing starts are projected to be 1.15 million units – weak activity but still a rather mild decline from the final quarter of 2007.The other components of GDP will hold on. Consumer spending will continue to expand, albeit at a slower pace. It is difficult to foresee a consumer spending contraction given the fundamental improvement in household balance sheets. Compared to two years ago, salary payments to workers have increased by $700 billion, four million additional net new jobs have been added, and household net worth has risen by $8 trillion – principally from a rising stock market. Wealth in homes has declined by $200 billion in the past year due to the lower home prices (on average). On a net average though, if you add up the above figures, households are in better financial condition. Consumer spending will not contract.Business profit appears to have topped out in the past two quarters. However, business spending will advance at a respectable pace because aggregate corporate profits are considerably higher now compared to just two years ago. Government spending nearly always rises. Net exports also look favorable given the weakness in the U.S. dollar. Foreign purchases of U.S. products will remain strong because U.S. products are competitively priced.Eye on the FedAll in all, we will easily escape recession – despite the anticipated screaming headlines of impending doom. The GDP reading for each of the successive quarters in 2008 will be positive: 2.2 percent in the first quarter, 2.6 percent in the second quarter, 3.0 percent in the third quarter, and 3.1 percent in the fourth. Job gains also will continue into 2008.But even a temporary contraction in GDP has some benefits. Despite a relatively high inflation reading in November (0.8%), weaker GDP growth will hold back inflationary pressure in 2008. It is likely we’ll see another rate cut by the Federal Reserve. The Fed Funds rate will fall by another quarter point to 4.0 percent in January. Mortgage rates will hover near 6 percent – nearly comparable to the 45-year low rates we encountered in 2004 and 2005 during the housing boom years. Note, however, that is forconforming mortgages and not jumbo rates. But once the economy gathers momentum, mortgage rates will tick modestly higher.Foreclosures and FraudUnfortunately, foreclosure rates will continue to rise in 2008. That is a given due to the weak underwriting standards of past loan originations. Subprime mortgage loss write-downs will also continue. (Write-downs are based on assumed anticipated losses and not actual losses.) Because of inactive trading of subprime debts, the market value of these “toxic” loans is unknowable. It is possible that the actual losses – after tallying the figures for the next several years – could be measurably lower. In my view, a considerable share of the recent spikes in default rates is due to investors walking away from their loan obligations. Fraud is also a factor. However, homeowners will fight hard to keep their homes, so the assumed rise in default rates based on a simple extrapolation of recent figures may not be accurate. Investors/speculators and fraudulent loans will have defaulted quickly, thereby leaving fewer in the potential default pool at a later stage.Recent mortgage originations are much less problematic. We are back to the basics of sound underwriting. Nonetheless, past weak lending standards will mean higher foreclosures well into 2008. Therefore, it is critical for homebuilders to sharply cut back production so as to not add to the already high inventory. As always, we go back to our mantra: All real estate is local. There are wide variations with no one neighborhood trend looking like another. Some areas will see housing activity and prices moving up and some moving down. Local real estate professionals are critical in properly ascertaining local market conditions. In the aggregate, the national home sales and home prices will be very similar in 2008 as in 2007.