By Martin Wolk
updated 6/27/2005 4:04:04 PM ET 2005-06-27T20:04:04

When Fed Chairman Alan Greenspan and his central banker colleagues hold their two-day midyear meeting on monetary policy this week, America’s booming housing market will be very much on their minds.

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It is certainly on the minds of economists participating in’s semi-annual roundtable, who describe the continuing housing boom as the biggest economic surprise of the year so far.

Whether or not prices have reached “bubble” levels in the most overheated urban areas, the housing market would hardly have to collapse to cause heavy economic damage, several of our panelists warn.

“The reality is, you do not need home prices to go down – all you need is for housing prices to stop going up,” said David Rosenberg, chief North American economist for Merrill Lynch. He calculates a flattening of housing prices could trim U.S. economic growth, currently running about 3.5 percent a year, by a full percentage point.

Rosenberg figures that over the past five years rising home values have added $4 trillion to the nation’s net worth, or 70 percent of the total rise in household wealth in that time frame. That “wealth effect” probably has translated to about $50 billion in additional consumer spending a year, adding half-a-percentage point to growth every year.

“A lot of the economy’s fortunes hinge on the housing market, and yet it doesn’t look like it’s all that stable to me,” Rosenberg said. “The last leg has been fueled by a mountain of leverage and a lot of speculation.”

Ethan Harris, chief U.S. economist at Lehman Bros., agrees that the economy could suffer even if the housing bubble gently deflates rather than collapsing in a Nasdaq-like implosion.

“Even if you don’t get  a national collapse, the housing market could cool the economy down,” he said. “We think that right now the housing market is generating more than a percentage point of stimulus to the economy. It’s reinforcing a construction boom and strong consumption. So even if the housing market were just to stop growing you’d gradually see that roughly 1.2 percent or so of stimulus disappear, and something else then would have to take up the baton for growth.”

“And then there is of course a  darker scenario where you have a pretty big shock to  confidence from the housing market,” he said. “I don’t think it requires that prices fall nationally. I think what is important is that enough major regions experience price declines that it really hurts those local economies and then it filters into the national economy. … It’s very hard to know what the other side of the bubble is going to look like, but we certainly should be on the alert for uglier scenarios.”

Not everyone on our panel agrees that the housing market is headed for a fall.

“I’m still bullish on the housing sector,” said David Lereah, chief economist for the National Association of Realtors, who admits that he has been surprised by the pace of home sales and price gains. “I don’t think we’re close to balloons popping. The supply is still very lean.”

Lereah acknowledges that some local markets are “bubbly,” and that those markets might be “vulnerable to a price retreat.”

“But I do not subscribe to the notion that there is an overall housing bubble in this country,” he said.

Nevertheless Lereah and some other panelists say the Fed and other banking regulators might have a role in reining in the worst excesses of the housing market, chiefly by ensuring that lenders are not overly aggressive in their use of products like interest-only loans and so-called “cash-flow ARMs” that allow borrowers to choose how much to pay each month.

“A lot of people who take those interest-only loans are doing it for a good reason,” said Harris. “They are stretching their budget to the limit in order to buy the real estate.”

Tuesday: What should the Fed do about housing?

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