Real Clear Analysis 5: How Bad is Housing?

The epicenter of the current financial crisis is widely believed to be the Housing sector. Therefore it seems useful to examine dynamics in the Housing sector to see if things are as bad as they may seem.

Americans are builders. Dating back to 1915, the value of new construction per year in the United States economy has grown – very steadily – at a 6.2% annual pace. About 45% of all construction over that time period has been Residential Housing. The Residential Housing sub-sector is prone to booms and busts. The chart below shows the progress of Construction, both Residential and Non-residential, since 1915. The data is the dollar value (in millions) of construction put in place each year:


The booms and busts in Residential Housing are difficult to see on the big chart, but can be extreme. For example, the Great Depression period illustrates that a housing boom typically produces a painful echo in the years that follow. Statistical analysis shows that the United States overbuilt housing by about $22 billion between 1923 and 1929. The boom was followed by a period of under-building between 1930 and the outbreak of war in 1941 of about $20 billion. At the peak in 1929, Residential Housing put in place was $4 billion. By 1933, the total had fallen to $0.5 billion, leaving an $3.5 billion “hole” in the economy.

The chart below illustrates the swings in Residential Housing Construction in the Depression period:

A similar analysis of the period since 1970 illustrates the booms and busts that marked recent recessions. Each of the recessions – except 2001 – were preceded by a period of overbuilding in housing. The periods of under-building have not been proportional to the overbuilding in dollar terms due to underlying growth. Nonetheless, the pullbacks have been dramatic.

The peak of Residential Housing in 1972 of $60 billion was followed by the 1975 nadir of $46 billion – a $14 billion nominal decline in activity but a $25 billion decline on a growth-adjusted basis.

The next peak, in 1986, was $55 billion above the trendline and part of an eight-year housing boom where $183 billion per year of new housing was constructed. The 1991 housing recession saw only $166 billion of new housing, $25 billion below the previous year and $77 billion below the peak on a growth-adjusted basis.

Between 1992 and 2002, the United States experienced a long period of steady growth right along the trendline.

From 2003 to 2007, however, the country experienced a sizable boom in Residential Housing totaling $329 billion above trendline expectations.

The chart below illustrates the build-outs and contractions from 1970 through 2007:


$329 billion is a lot of money. But how does it compare with past periods of overbuilding? The $3.5 billion “hole” in 1933 was nearly 6.2% of GDP. The $25 billion hole in 1975 was 1.5% of GDP. In 1991, the $77 billion hole was 1.2% of GDP. The overbuilding of 2005, which totaled $126 billion, was about 1.1% of GDP.

The overbuilding of 2003-2006 is clearly not on the scale of the Great Depression. It isn't even on par with the 1970s or 1980s. The boom of the late 1970s was $65 billion too large over four years and the bust erased $18 billion over two years on a growth-adjusted basis. The boom of the late 1980s was $300 billion too large over seven years and the bust erased $25 billion in two years.

The United States’ reaction this year has been far more severe. The annual rate of Residential Construction at the end of 2007 dropped to $414 billion from $641 billion in 2005. The rate to-date in 2008 is only $337 billion., or $304 billion below the 2005 peak and $302 billion below trendline expectations. The current rate is enough to correct the entire three-year overbuilding boom in one year. The $304 billion “hole” in the economy equates to 2.2% of 2007 GDP.

The chart below illustrates what has happened. The 2007 and 2008 data points are annual rates rather than actual totals:

It appears likely that the United States is currently over-correcting by a wide margin. Are we headed to another Great Depression? An economic "hole" of 2.2% of GDP is very, very far from 20%. Housing alone would not seem able to create the sort of long-lasting economic crisis last seen in the 1930s. Like the 1920s, though, a lot of other capital build-outs have been happening, it is the size and shape of those build-outs in aggregate that is important to understand.

To be continued