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Housing Market Fizzles, Raising Risk of 2007 Recession

by Adam Price |
January 24, 2007
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San Jose, CA - Between September of 2005 and December of 2006 permits to build new homes went down 28%, as home sales have dropped and prices have started to fall. In the last 50 years there have been seven other declines in building permits of 25% or more, and every single one has been followed by a recession, the most recent being the 1990 recession.

Falls in building permits and the construction of new homes leads to fewer jobs both directly in terms of less workers needed to build homes and indirectly in terms of fewer real estate, mortgage and building-material store workers. Home construction jobs were already falling at a 7% annual rate during the last three months of 2006 and will fall further as fewer new homes are started than are completed.

Homes have become a super-sized credit card for many households who borrow against their home’s increasing prices. Last July through September, homeowners borrowed over $100 billion through refinancing and home equity lines of credit. This amount is only half of the amount borrowed the same three months the year before, which could mean less consumer spending in the future, also slowing the pace of the economy.

In addition to the housing market, interest rates are also signaling a slowdown or even a recession in the future. Typically, long-term interest rates (for example, the rate that the U.S. government pays to borrow money for ten years) are higher than short-term rates on one or two month loans. However, for the past six months longer-term interest rates have been lower than short-term rates. This so-called ‘inversion’ always happens before a recession, although not every inversion is followed by a recession.

Many small and medium sized businesses are having a harder time borrowing money as sales slow and interest rates rise. While big businesses and the government are able to sell bonds - essentially corporate and government IOUs - to investors in the United States and around the world, smaller businesses must rely on banks and other finance institutions who are rejecting more applications as business fall behind on their payments.

Any recession could be a severe test for the U.S. economy. To get the economy out of the last recession in 2001, the Federal Reserve Bank slashed interest rates, setting off a boom in the housing market. At the same time businesses slashed jobs and sent their work outside the U.S., fattening their profit margins. But this has left households with record levels of debt and the United States has had to borrow hundreds of billions of dollars each year to pay for record imports.

A sudden drop in household borrowing or a sharp slowdown in money coming in from the rest of the world to the United States could trigger a more dramatic economic crisis. This has only been seen in indebted Third World countries in the last few decades, when a dramatic drop in the international value of country’s money (the ‘exchange rate’) coupled with sharply higher interest rates at home led to a severe recession and inflation.

Underlying the of danger of recession is the fact that the U.S. economy is periodically hit by crises of overproduction, where despite people’s real needs, corporations are no longer able to able to produce goods and services profitably. Big corporations respond by laying off workers and closing down workplaces.

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