March 5, 2008 (Housing Market Monitor)

Housing Market Monitor

Weakness Spreads to the Non-Residential Sector

March 5, 2008

By Dean Baker 

"Mortgage bailouts provide far more benefit to banks than homeowners." 

One of the factors that has offset the economic impact of the collapse of the housing market has been a boom in the non-residential construction sector. In real terms, this sector had expanded by 30 percent between the fourth quarter of 2005 and the fourth quarter of 2007, adding 0.3 percentage points to GDP growth in 2006 and 0.5 percentage points to GDP growth in 2007.

The story here is that the housing boom had pulled resources away from the non-residential sector. When residential construction tapered off in 2006 and collapsed in 2007, the non-residential sector suddenly had no difficulty getting the workers and materials needed to expand. However, the pent-up demand has been met and excess capacity is now appearing in many parts of the non-residential market. As a result, the most recent data indicate that non-residential construction is now contracting.

Non-residential construction overall in January was down by 0.7 percent in nominal terms from its November level. This would imply a real decline of approximately 1.3 percent in this two-month period. Construction of lodging was hardest hit, with a nominal decline of 5.7 percent, while commercial construction fell 4.6 percent. It is likely that the decline in non-residential construction will continue for the immediate future, shifting a big positive component in growth to another source of drag. It also appears that some of the major banks have made loans in the non-residential sector that are going bad, which will compound the losses that they are incurring in the residential mortgage market. 
Bernanke’s speech yesterday to the Independent Community Bankers gave a boost to plans for a more extensive bailout in the housing market than the measures that President Bush has placed on the table to date. Bernanke called on banks to write down loans to the current market value of the houses. This would be a big hit to mortgage holders. They are unlikely to take such a step unilaterally. Of course there are many proposals that would sweeten the deal with government money coming either directly in the form of mortgage buyouts by the Federal Housing Authority (FHA) or indirectly in the form of guarantees.  

In assessing the merits of such proposals it is important to follow the money. The immediate beneficiaries would be the banks who are getting money or valuable guarantees from the government. It is questionable whether homeowners benefit in these plans since many will be living in homes that are still falling in price. This means that they are unlikely to accumulate equity, especially if the terms of the bailout give the original mortgage-holder first claim to any equity upon the sale of the house. In addition, homeowners are still likely to find themselves paying far more in ownership costs than they would to rent a comparable housing unit.

With spring rolling around, it is worth remembering the seasonality of the housing market. Housing sales and construction are hugely seasonal, with the spring and summer being far stronger than the winter months. This means that a downturn matters much more in the months coming up than it did in the December to February period. (Construction employment is typically about 10 percent higher in July than January, while existing home sales can be expected to be 80 percent higher in June than in January.) As a result of the slump, hundreds of thousands of construction workers who would ordinarily be getting hired in the spring months will not be this year.

The 30-year mortgage rate fell by almost 30 basis points to 5.98 percent from 6.27 percent the prior week. This reflects expectations that the economy will continue to weaken in the months ahead. Of course, the continued fall in the dollar and the resulting inflation pushes interest rates in the opposite direction.

A noteworthy item in the Federal Reserve Board’s release of the fourth quarter Flow of Funds data tomorrow is the drop in the ratio of home equity to value (Table B.100, Line 50). This will fall below 50 percent for the first time ever.


Dean Baker is co-director of Center for Economic and Policy Research in Washington, D.C. CEPR's Housing Market Monitor is published weekly and provides an incisive breakdown of the latest indicators and developments in the housing sector.


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