The Beige Book Hints at a Housing Spillover

The Fed's Beige Book painted a picture of benign inflation and mild growth. Housing remains very weak, but no wide-spread housing spillover are yet obvious:

"Residential real estate markets continued to weaken, and most Districts reported additional declines in home sales, prices and construction."

"At firms without direct ties to real estate and construction, contacts are still wary that credit tightening and slowing construction might slow activity in their industry, but there is cautious optimism because few see much evidence of such spillovers at this time."

"Consumer spending expanded, but reports were uneven and suggest growth was slower in September and early October than in August."

"Labor markets remain tight across much of the country, and there continues to be moderate upward pressure on wages and benefits. Job growth eased in some regions, however, and wage pressures softened."

"Competitive pressures are restraining retail price increases in many instances."

However, when we look at some of the regional reports, the signs become a little more worrying. If you look at the Case-Shiller home price indices, you'll find that the hardest hit areas are in Florida. Prices in Miami and Tampa are down an average of 6.85% YTD. If we take a closer look at the report from the Atlanta District, which is the district that includes Florida, we find the first hint of a spillover from housing:

"In Florida, several contacts noted that the pace of hiring has slowed, with workers laid off from the homebuilding sector finding it more difficult to find alternative employment."

You get a similar picture on the West Coast. California, Las Vegas and Phoenix have also seen significant recent declines in house prices, with their respective Case-Shiller price indices down an average of 3.77% YTD. If we look in detail at the San Francisco District report, which covers all the western states, we again start to see the first signs of spillover from housing to broader weakness in consumer and business spending:

"Reports on retail sales suggested growth on balance but at a slower pace than in the last few survey periods. ... Demand for home furnishings fell further as the slowdown in housing markets intensified."

"Sales decelerated for advertising agencies and providers of media services, as weak demand for ... home furnishings held down advertising expenditures...."

Now contrast that with the details of the Dallas district, where home prices are still firm (up 2.1% YTD in Dallas):

"The [Dallas Fed District] economy is still digesting ... a slow down in homebuilding and residential real estate, but there continues to be little evidence that this is significantly affecting the broader District economy."

Housing is beginning to spill over. The question is whether there will be enough evidence that the spillover effect is big enough to convince the hawks on the FOMC to vote for a cut on Oct 31, rather than waiting until the Dec 11th meeting for more evidence to appear. Any way you cut it, though, the odds of an additional rate cut have gone up.

Recommended Reading on Housing

Recent Developments in Real Estate, Financial Markets, and the Economy by Eric Rosengren
President, Federal Reserve Bank of Boston
October 10, 2007

Real Estate in the U.S. Economy, by William Poole
President, Federal Reserve Bank of St. Louis
October 9, 2007

Proceedings of the 2007 Jackson Hole Symposium on Housing, Housing Finance and Monetary Policy, especially the papers by Leamer, Shiller and Mishkin.
September 1, 2007

Poole on Housing and Recessions

Bill Poole, the outgoing President of the St Louis Fed, gave a speech yesterday on housing that essentially endorsed Ed Leamer's view from his Jackson Hole talk that housing recessions are almost always the proximate cause of full-blown recessions:

Consider Figure 6 ... Each line shows the average contribution to real GDP growth (in percentage points) eight quarters before and after each cycle peak from 1953 to 2001. There are three lines representing the contribution to real GDP growth from residential fixed investment (housing), nonresidential structures (commercial and industrial), and business equipment and software investment. These are the major components of private fixed investment.

Residential investment typically turns down ... well before the other two investment components. The figure shows that, on average, housing peaks about three quarters before a recession starts....

Figure 6 makes clear that housing... leads the economy into recession and out of recession.

Here's the graph of year-over-year changes in residential investment:

So if past is prologue then we've got a problem, because it means we're already in a recession.

Anatomy of a Recession (Ed Leamer at Jackson Hole)

This year's Jackson Hole Symposium was on Housing, Housing Finance, and Monetary Policy. If you're interested in learning more about the current subprime mess, the symposium proceedings are a good place to start.

Ed Leamer, from UCLA, presented a paper on Housing and the Business Cycle (pdf). It's well worth reading in detail. He gives a very thorough and readable analysis of the last 10 recessions, detailing how recessions start (a downturn in residential housing investment, not housing prices), how they spread (weakness in consumer spending first on durables, then non-durables, then services, but not business spending), how they deepen once they've started (a fall in business investment in equipment, software and inventories), and finally how the end: housing investment recovers, then consumer spending recovers, and lastly business spending recovers. Eight of the last ten recessions fit this mold; 1953 and 2001 were the two exceptions.

The recovery is aided by cuts in the Fed funds rate, which disproportionately stimulate housing demand and which have historically signaled the beginning of the end of a recession. This time, however, the Fed's already used up those bullets during its last round of cuts in 2001-2003. With the huge housing inventory overhang, there's no more housing investment left to stimulate. So if consumer spending starts to fall, interest rate cuts by the Fed might support housing prices by making mortgage finance cheaper, but housing investment isn't going to recover in the way that has typically been required to end a recession. So a consumer recession could be long-lasting.

The paper is long (73 pages), but lots of graphs and his conversational writing style make it easy reading.