Economic Recovery only with Housing Recovery?

After a long respite, I've had a few things bother me enough to consider them in long form. The first is the continuous drumbeat that the economy will not recover without a housing recovery. I want to challenge that hypothesis.

I agree that as a function of addition in GDP figures that if fixed residential investment does not stop plummeting, GDP will have a hard time going up. Housing has been the anchor. Will it continue to be? Do we need a rapid recovery in housing to have a rapid recovery in the economy? My opinion: only if we want the next economy to look like the last economy. Of course it's easy to see what was and wish for it to be so again. That thinking is short sided and will miss whatever eventual recovery will eventually unveil itself.

I decided to use the new FRED excel add-in to pull fixed residential investment (FRI) and GDP numbers since 1947 to find out how large of a role fixed residential investment plays in our economy and in economic recoveries. I tracked change in FRI over change in GDP to find the mean contribution to GDP of 5.7% with a standard deviation of .547. At first glance, I surmised that housing, although relevant, was not THE driver of our economy pundits often make it out to be. With 258 observations, however, the 95% confidence interval for the entire period is 0.11%-11.35%; a bit of excess kurtosis if you will. Here's the chart for the whole period.

During the 2000s, the mean contribution to GDP from FRI was 7.7%. The main damage was done shortly after Greenspan lit the match lowering rates from 6.5% to 1% to cushion the blow from the internet bubble bursting. An initial explosion of FRI in Q3 2001 notwithstanding, FRI contributed on average 12% to GDP growth for the next four years; that uninterrupted growth compounded to trade one misallocation in our economy (internet stocks) for another (housing). But has housing always been the driver of our economy? That lead me to think about FRI as a proportion of GDP. It has oscillated between 3-6% except after the bursting of the housing bubble and is now at 2.22%.

Amazingly, even with a bubble, housing, our Savior that has since passed whose Resurrection we eagerly await, only retraced its range from decades earlier and didn't even make a new high! That lead me to define exactly what the BEA measures as FRI (pg8):

Residential fixed investment consists of all private

residential structures and of residential equipment that

is owned by landlords and rented to tenants. Residen­

tial structures consists of new construction of perma­

nent-site single family and multifamily units,

improvements (additions, alterations, and major

structural replacements) to housing units, expendi­

tures on manufactured homes, brokers’ commissions

on the sale of residential property, and net purchases of

used structures from government agencies. Residential

structures includes some types of equipment that are

built into the structure, such as heating and air condi­

tioning equipment.

Did you catch it? 'New construction, ...improvements,.. and net purchases of used structures from government agencies.' FRI does not include purchasing existing property or any refinancing. That helps explain why during the bubble FRI/GDP did not reach new all time highs. All existing home sales are not captured in FRI investment. What proportion of home sales were existing?

Consistently over 83% of all home sales during the housing build up were existing and were overlooked when counting FRI. The stretched valuation of housing was not considered when calculating GDP and overlooked by many as a result. Those high prices were paid for on credit as rates moved lower and lending standards eased. It's fair to say, the housing picture and its impact on the economy has been convoluted with what was the most recent bubble: credit.

-Insert growth in personal credit

-Slump in savings rate

As we all know (I hope), what we experienced the last few years was the popping of a credit bubble with an impact on all assets, real and financial. The reason housing is now the topic of conversation, and the hoped for Savior, is because house prices were the biggest manifestation of credit expansion on the balance sheet of average Americans. To expect a housing recovery to power the economy is to expect a recovery in credit. Remember, the action of expanding credit causes debt to appear on the balance sheet of the actor. How did that work out last time for most people. Fool me once, shame on you..

It's also important to remember those passed transgressions and their poor prints on the balance sheet of consumers and the opposite reaction to the balance sheet of banks. Irving Fisher and debt deflation would encourage us to boost house prices to ease the overhang but if that's the case, lets not get all excited when home builders catch a bid in the stock market and housing starts increase; it's only adding to supply.

So will the recovery be led by housing? Highly unlikely. It could easily be health care or productivity advancements, or a range of other things but most likely not housing or anything else credit related.