Will housing mess drag economy down with it?

John W. Schoen • Profile • E-mail

As the housing market continues to grind through its worst slump in over a decade, some readers, like M.H. in Columbus, Ohio, are wondering how long it will take before the economy starts to slump along with it. But there are still some buyers out there. Frank in Missouri is getting ready to buy a house and  wants to know if shopping for a mortgage is going to hurt his credit score.

If the "housing mess" gets worse and the ripple effect works its way through every aspect of the U.S. and world financial markets, more so than anyone thinks/predicted, could it lead to the collapse of the U.S. economy, possibly thrusting the country into another great depression or worse?
-- M.H. Columbus, Ohio

Anything is possible, including the destruction of Columbus, Ohio, by a huge asteroid.  But a lot more things would have to go wrong for the U.S. economy to “collapse” and get stuck in a extended contraction on a scale comparable to the Great Depression.

First off, the immediate cause of the housing slump is the end of an unsustainable boom that was fueled by (in no particular order): easy lending, rampant speculation, fraud and predatory lending. So part of the contraction in housing is from a ridiculously overextended level.

It’s quite possible that a prolonged, deep slump in homes sales and construction could bring a recession, which often is defined as two or more consecutive quarters of negative growth and/or job losses. That’s what happened the last time real estate hit a major slump, though the resulting recession in 1990 was relatively mild as these things go.

There are some people on Wall Street who worry that we haven't seen the worst of the mortgage mess. The stock market's big sell-off Friday was due largely to fears that losses by big banks and other investors may be worse than originally thought.

There are also fears that interest rates may be headed higher as lenders demand more money to offset what they see as increased risk. If those fears go too far, we could see a "credit crunch" — when a widespread slowdown in lending throws sand in the gears of the economy.

In any case, we’re not seeing signs of a national recession at the moment. Though job growth seems to have slowed a bit in July, the economy turned in a solid 3.4 percent annual growth rate in the second quarter and added 2 million new jobs in the first half. Economists who keep an eye on the data see a higher risk of a downturn than they did six months ago, but the general consensus seems to be that the odds are still against a recession.

One major reason the economy is holding up so well is that in many parts of the world —where they probably haven’t even heard of the U.S. housing slump — the economy is growing even faster. That’s helped raise demand for U.S. products from overseas.

Still, parts of the economy are hurting. Manufacturing industries are still shrinking, shedding some 175,000 jobs over the past 12 months. Despite strong overall job growth, some regions are lagging. Ohio, Puerto Rico and Michigan posted net job losses in the first half of the year.

And, to be sure, the housing industry itself is in a deep recession; many of the people who have lost homes are in dire financial circumstances. But a housing slump, by itself, doesn’t necessarily drag the rest of the economy with it. The housing industry represents a relatively small piece of the U.S. economy: about $1.5 trillion of the $13.8 trillion in GDP. Government spending at $2.7 trillion makes up a bigger piece of the pie, for example.

Some 70 percent of the economy is based on consumers buying goods and services, anything from food to health care to trips to Disneyland. Demand for these products and services remains strong. As long as people have the money to spend, and they keep buying, the economy should be just fine. There are some signs that consumer spending is taking a hit from higher energy prices and worries about the housing market. But so far, overall wages have been going up.

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