When last we looked, a big part of the U.S. economy was related to real estate, therefore it was curious to see the reaction to tough news during the past week.
On Wednesday the Commerce Department announced that April building applications dropped 28.1 percent from a year earlier, the biggest fall since 1990.
Also on Wednesday the Dow Jones Industrial Average closed at 13,487.53 -- a record, up 103.73 from the day before.
Isn't the stock market supposed to be a guide to future growth and earnings? Don't building applications hint at future home construction activity? Don't a lot more new homes down the road suggest good economic news while fewer new homes imply just the opposite?
A permit doesn't say that you'll build, it merely says you have the right to build. If builders are not even bothering to get building permits, then how much confidence do they have in the future?
"The crisis in the subprime sector has infected other parts of the mortgage market as well as consumer psychology, and as a result the housing outlook has deteriorated," says David Seiders, chief economist with the National Association of Home Builders. "We're now projecting that home sales and housing production will not begin improving until late this year, and we're expecting the early stages of the subsequent recovery to be quite sluggish. There still are tremendous uncertainties regarding our baseline forecast going forward, owing largely to the subprime crisis that is having widespread effects throughout the mortgage market."
Since when are "tremendous uncertainties" good for the stock market? Who benefits from a "crisis" in subprime lending?
It's not as though housing is a minor part of the economy. The Bureau of Economic Analysis says that in 2006 we spent $405 billion for household furniture and equipment, $506 billion was related to household operations, and $1,382 trillion went for housing. That's a total of $2.29 trillion in a $13.254 trillion economy, or 17.3 percent of all goods and services.
Beat up the housing sector and a big slice of the national economy can be impacted -- and not for the better.
But, as Federal Reserve Chairman Ben Bernanke said last week, don't worry.
"We are likely to see further increases in delinquencies and foreclosures this year and next as many adjustable-rate loans face interest-rate resets," said Bernanke. "All that said, given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system."
The catch is that subprime lending is only a part of the housing market. Housing permits are another part. The tightening of loan standards for subprime and Alt-A borrowers by major lenders is certainly an issue. Reduced unit sales for existing homes are a concern and so are price declines in many communities. Less real estate activity means reduced tax revenues, not good news for local governments.
Taken in total, a slowdown in real estate does show up, it is real and it is relevant.
According to the Federal Reserve, the real gross domestic product is up 2 percent during the past year. That's little more than half of the 3.75 percent growth rate seen during the preceding three years.
"The cooling of the housing market is an important source of this slowdown," says Bernanke. "Sales of both new and existing homes have dropped sharply from their peak in the summer of 2005, the inventory of unsold homes has risen substantially, and single-family housing starts have fallen by roughly one-third since the beginning of 2006. Although a leveling-off of sales late last year suggested some stabilization of housing demand, the latest readings indicate a further step down in the first quarter."
If the stock market truly reflected national economic interests it would not be at record levels. Instead, it would weigh the concerns of owners in selected markets with lower home values, lenders who have closed, contractors who have had to cut back and investors who may now feel that mortgage-backed securities are not a sure thing. It would reflect that the federal deficit is huge and growing, that the balance of payments is entirely woeful, that it now takes two dollars to buy one English pound -- and that such factors may pressure interest rates to rise. And surely the stock market -- that predictor of future economic activity -- should be concerned that the real estate downturn is not yet over.
It's not real estate that's irrelevant, it's Wall Street that's out of touch -- and that should worry us all.
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