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Is reliance on housing bad for U.S. economy?

The U.S. economy is more dependent on housing than it has been in a half-century, as the sector fuels consumer spending and has accounted for nearly three-quarters of the nation's job growth in the past five years.
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The U.S. economy is more dependent on housing than it has been in a half-century, as the sector fuels consumer spending and has accounted for nearly three-quarters of the nation's job growth in the past five years.

As a result, economists worry that the housing slowdown that began late last year could hurt the broader economy more than past real estate downturns, although other parts of the economy appear to be accelerating.

What makes the real estate boom of the past decade unusual is that its effects have reverberated far beyond closely related sectors such as construction, driving sales in places as varied as furniture stores and motorcycle showrooms, especially in the Washington area and others where home prices have soared particularly rapidly.

"People know they can always refinance or flip their houses, so they are willing to spend more," said Matt Ross, sales manager at Coleman PowerSports in Falls Church, who figures that at least 20 percent of his sales of motorcycles, motor boats, and jet skis are to people who pay for their purchase using home equity.

By almost any measure, the U.S. economy is built on housing more than in the past. In 2005, investment in housing constituted a higher proportion of the goods and services the nation produced than it has since 1950, when the nation was experiencing a massive postwar housing boom. The proportion of jobs in real-estate-related fields is the highest it has been since at least 1970.

Locally, there is strong job growth in sectors other than housing. The value of home transactions in the region was nearly as high as federal procurement spending in the region last year, though each dollar spent by the government generates significantly more economic activity. But Washington area residents took more money out of their houses through mortgage refinancing and home equity loans, as a proportion of income, than those in most other cities, which could mean local consumers' spending has depended more on housing than in most places.

Now the companies that have benefited from this expansion are bracing for the great unwinding. The nation appears to be entering a period in which the role of housing in the economy is returning to something more resembling its historical norms.

A small group of economists argue that housing prices in many parts of the nation, including the Washington area, have so outstripped those supported by economic fundamentals, such as income levels, that they are due for a painful and rapid correction that could cause a recession. But most mainstream economists believe that the unwinding of the housing market's outsize role in the economy will be gradual and come just as other industries take over as economic drivers.

‘Drag on the economy’
Nationally, the number of homes sold declined every month from August to January, according to the National Association of Realtors. Builders started work on 4.8 percent fewer units of housing in February than a year earlier, following years of sharp increases in construction.

So far, the housing slump appears not to have caused much economic distress, but the consensus of Wall Street economists' predictions is that growth will slow in the second half of the year, in part due to the housing slowdown.

"Clearly, housing is going to be a drag on the economy; the question is how much does housing slow and how quickly," said Dean Baker, co-director of the Center for Economic and Policy Research and a certified housing bear who expects a housing slump that will lead to recession.

A more common view among economists is that a cooling in the housing market would be only a mild drain on the economy.

"There will be losses in housing-related sectors, but I think other sectors will take up the slack," said Eugenio J. Aleman, a senior economist with Wells Fargo & Co.

Even if he's right, a housing slowdown could have ripple effects down to the corner paint store. Monarch Paint and Wallcovering Co., with three stores in the District, has benefited more than most from the long boom in housing, with double-digit-percentage sales increases in 2003 and 2004, said President Victor K. Krause. Those good times led the company to increase its staff 10 percent and spend about $75,000 a year on new computer systems, paint-mixing machines and other capital expenditures.

Sales growth has slowed in recent months, Krause said, which he figures is due to fewer people buying new houses and apartments they wish to have painted. If the pattern continues and sales growth slows further or stops, he plans to hold off on any new capital expenditures or hiring. "You reinvest those extra dollars that come in," Krause said, "but you don't do that if the dollars aren't there."

Real estate helped pick up the job-market slack that resulted when the high-tech bubble burst five years ago, saving the region from the severe economic slowdown some predicted. Marla Selko, for example, worked in sales for a company that provided online education services until investors in her old employer pulled its funding during the tech collapse. Looking for work in 2002, she decided to start a business that refers people to home remodeling and other contractors, called Urban Referrals, which has been fueled in part by the strong housing market.

The question is whether another engine will come in and replace housing. The Washington area is better positioned than much of the nation in that regard. Nationally, real-estate-related industries accounted for 74 percent of new jobs over the past five years. Locally, they account for only 21 percent, because in the Washington area other sectors have grown faster.

At the end of 2005, 11 percent of Washington area jobs were held by real estate brokers, construction workers, mortgage brokers or otherwise tied to real estate, according to an analysis of Labor Department data by Moody's Economy.com. That's the highest level in the 35 years the data go back.

Indeed, there were more than 12,000 members of the Northern Virginia Association of Realtors at the end of last year, twice as many as in 2001. "If the volume of business declines just a little bit, there won't be enough business to support that many people," said Dave Hawkins, managing broker of McEnearney Associates Inc. in Alexandria, who expects those numbers to eventually drop.

There are other ways housing has influenced the economy that could leave the region vulnerable.

The wealth effect
Economists call one the wealth effect. It's the degree to which rising prices of homes (or, in the late 1990s, stocks) lead to people spending more than they would otherwise. It's notoriously hard to measure, and economists can only guess at its exact scope, but it works through different ways. For one, when people see their house appreciating sharply, some feel less need to save as much as they would otherwise, resulting in more money to spend on everything else. For another, rising home prices and low interest rates have led many Americans to refinance their mortgages or take out home equity loans, giving them more money to spend.

Economy.com figures that mortgage refinancing put money in Washington area residents' pockets equivalent to 14.5 percent of personal disposable income. That's the 14th-highest rate among major metropolitan areas, behind mostly cities in California and Florida.

"Those economies where housing has gone skyward are most vulnerable as housing comes back down to earth," said Mark Zandi, the consulting firm's chief economist.

Despite the risks ahead, some businesses that have benefited from the housing boom say they are confident that they will keep growing even as housing slows.

Case Design/Remodeling Inc., in Bethesda, has doubled to 300 employees since 2001, fueled in part by homeowners' confidence in investing in their homes and cheap money available through mortgage refinancing and home equity loans.

‘Time out’
President Mark Richardson said he is confident that business will keep growing strongly even with the housing slump, as people hire his company to make improvements to their current homes rather than buying a new place.

So what happened in 1989, the last time the housing market entered a slump? "Oh, that was painful," said Richardson, who had to cut his staff as sales of remodeling services declined. "The market dropped off so dramatically and so quickly. People became very gun-shy. But then during that era, you had home appreciations that were double-digit in the 1980s, and all of a sudden, it went into negative territory. It made people say 'time out' and not want to do anything."

Staff writer Sandra Fleishman contributed to this report.