Why This Economic Downturn is Different

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This article reports on the demise of the new home construction market. Fewer are being built and it is more difficult to sell those which are being built. Existing home sales are driving the market and many of these sales are foreclosures or short sales which drive down prices. !.4 million construction jobs have been lost but this understates the job loss because the sale of new homes generate lots of other sales and services which are in decline. Just imagine what goes into a new home and all of the services that are generated by getting a mortgage, closing the sale, and landscaping the lot and you get the picture.

It has been common to refer to the 30 year period prior to the financial crisis as the "Great Moderation". We had several modest recessions during that period and very fast recovery's. That is because all but one of the recession was triggered by the Federal Reserve and so were the recovery's. This was done very simply by raising interest rates to slow down economic growth when inflation was a threat. This reduced the sale of interest rate sensitive purchases, and new construction sales fell and reduced economic growth. The recovery's were produced by lowering interest rates and restarting the sales of new homes. Alan Greenspan was viewed as a wizard by his ability to moderate business cycles, which can be affected by stepping on the brakes or pushing on the accelerator of new housing starts.

This recession and recovery are different in several respects but real estate is at the center. The collapse of the housing bubble brought down the global financial system with it, and we experienced a sudden and dramatic decline in global economic activity. One of the consequences was a hugh decline in tax revenues, which along with the cost of bailing out the banking system, had a major impact on the public balance sheets, which limited government response to the recession. The fall in housing prices led to a large decline in household wealth as well. Households were no longer able to borrow against the rising value in their homes and they began to reduce their leverage. In effect, we had a balance sheet recession in which households, government and the banks had to restore their balance sheets simultaneously. That is why this recovery has been longer and why it continues to depend upon restoring order to a housing market that will continue to be distressed until the glut of impaired mortgages are washed out of the system and home prices are stabilized.