Soft housing market worries US

Ground Floor: As the US mid-term elections approach, the difficulty for the White House is knowing whether Iraq or the economy will most influence the voters, writes Sheila O'Flanagan

Usually, as Bill Clinton reminded himself, "it's the economy, stupid". But the situation in Iraq is generating far more headlines than the domestic situation. When it comes to the polls, though, the domestic situation is nearly always the clincher. Either way, neither Iraq nor the economy is exactly going to plan. News from Iraq is unremittingly awful. At the same time news on the economy, where third-quarter GDP growth has just been reported at a lower-than-anticipated 1.6 per cent, is not exactly great. It's difficult to know whether anything can bail the Republicans out of the mess that is Iraq. Can anything bail them out of the economic downturn instead?

One of the main problems on the economic front continues to be the state of the housing market. Over the past few months there has been continued focus on the hard landing versus soft landing debate. The hard-landing theorists have a lot to support their argument: average new house prices have fallen by 9 per cent in the year ending September, the fastest decline in 36 years. Residential construction fell by more than 17 per cent in the same period and the decline in house building accounts for about 40 per cent of the fall in GDP. Inventories of unsold homes show about 6.4 months' supply in the market. New home sales are down 22 per cent on the year and mortgage applications are down 20 per cent. Looking at the statistics, it's hard to feel optimistic.

As every Irish citizen worth his or her salt can tell you, feeling optimistic about the housing market is an integral part of being optimistic about the economy as a whole. The notion that you are sitting on an appreciating asset allows you to think positively about future spending. The idea that your bricks and mortar might be worth less in a few months time than you've paid for them induces shivers of unease among homeowners.

Nervousness about the housing market is one of the reasons why Americans have been spending less over the last year or so. According to the National Association of Realtors, the average home price in the US went up almost 50 per cent in the five years to end 2005. Those rising prices helped to insulate Americans from the negative effects of higher oil prices, scandals on Wall Street and events like Hurricane Katrina. Knowing that the value of their homes was rising, even as their monthly outgoings increased or the value of their stock portfolios fell, left Americans feeling secure about their financial situation. The idea that owning a home might not mean owning an appreciating asset - that it might, in fact, be an increasing burden - is one that is alien to many US homeowners. Sellers are reluctant to accept the new reality and have been holding out for the sort of prices they've grown to expect, which is why the inventory of homes is remaining stubbornly high.

The housing market contributed around $2 trillion to the US economy last year and 23 per cent of GDP when you include household-related spending, a Harvard University study showed. That's a massive amount of support to the domestic economy and shows how dependent it is on the feelgood factor of appreciating house prices. And anything that lessens that contribution is very, very worrying for the people in the White House.

However George Bush's old friend, Alan Greenspan, has weighed in with some words of comfort. Greenspan commented last week that despite the fact that the economy had gone through a "very weak" patch during the summer - mostly due to the decline in construction - the outlook was now "reasonably good". That's a bit of a change of tack for Greenspan who, in his pre-retirement speech in August of last year, warned that the housing market could crash and said that people were investing in property as though it was a one-way bet. He reminded his listeners that history hadn't dealt kindly with investors who ignored risks.

As his comments rippled through the market, share prices fell and people acknowledged that investing was a risky business. But almost as quickly as prices went down, they recovered again. The housing market was quite happy to continue with its own bout of irrational exuberance, too. People listen to the warnings of gurus like Greenspan. They know that he has a point, but history hasn't always dealt kindly with investors who stay out of the market either.

However, it hasn't been a good year for many US homeowners who have seen the value of their investment fall sharply and many may wish that they'd heeded Greenspan's warning. But now he feels that most of the negatives are behind the US and the fourth quarter should show an improvement on the third. He assured worried house-prices watchers and home owners that the situation was showing signs of stabilisation.

The worry about US housing prices doesn't, of course, only extend to the US economy. Europe watches it with some anxiety. The last thing that Europeans want, with the euro-zone economies currently outperforming the US, is to have some kind of housing-market contagion rocking our boat.

In the end, it will always be the economy, stupid.

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