November 20, 2002

By David F. Seiders
NAHB Chief Economist

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Digesting a barrage of economic, political and geopolitical events . . .
Financial markets, consumers and businesses are trying to digest a barrage of events across both the national and international fronts. It’s been about two weeks since three major domestic events occurred that figure to have substantial impacts on financial markets and the U.S. economy – the mid-term Congressional elections, the resignation of beleaguered SEC Chairman Harvey Pitt, and the dramatic half-point cut in short-term interest rates by the Federal Reserve. The jury obviously is still out on the ultimate net impact they will have.

Then there’s the recent wave of FBI warnings regarding heightened risks of domestic terrorism and, on the international front, weapons inspectors now heading back to Iraq on the heels of a tough-sounding resolution by the U.N. Security Council. To further complicate the international scene, the Bank of England and the European Central Bank have refused to follow the Fed’s lead, passing up recent opportunities to lower their policy rates despite obvious deterioration in the economies under their care.

Uncertainty dominates the decision-making . . .
These recent events have rendered systematic economic risk assessment virtually impossible. Uncertainty has taken over, freezing up economic decision-making and causing economic policymakers to do unconventional things.

Business surveys reveal a persistent reluctance to hire and invest, despite insistence by economists (including yours truly) that the economic recovery is well underway. Consumer spending, the main bulwark for the economy throughout the recession of 2001, has weakened recently under the pressure of huge cumulative stock market losses, uncertainty about future employment prospects and terrorist threats. In financial markets, massive uncertainties have been reflected in a manic-depressive stock market and near-record quality spreads in the bond markets. [return to top]

Greenspan explains the Fed’s words and deeds . . .
The half-point rate cut by the Federal Reserve on November 6 was larger than the markets had expected, and the accompanying statement that described the upside and downside risks to the economy as “balanced” struck many observers as incredible or even disingenuous. Indeed, the strange combination of words and deeds looked like a tortuous compromise and prompted widespread speculation about power shifts within the Greenspan Fed.

On November 13, Chairman Greenspan marched off to Capitol Hill to testify before the Joint Economic Committee and field questions about the Fed’s behavior. The Chairman stressed the uncertainties about the current situation, particularly the “heightened geopolitical risks” surrounding Iraq. He also characterized the aggressive November 6 rate cut as “cheap insurance” against the small risk of a significant decline in the economy and said that the very low inflation situation in the U.S. tilted the Fed’s decision toward a half, rather than a quarter point, rate cut.

Regarding the balanced risk assessment, the Chairman stressed the Fed’s belief that the current economic situation is a “soft patch” and suggested that the rate cut would be reversed if the economy does not slip further in the months ahead. [return to top]

Housing remains strong in the midst of uncertainties . . .
The housing market has continued to perform quite well in the face of massive uncertainties at home and abroad. Mortgage rates had fallen to the lowest level since the mid-1960s before the Fed’s recent cut, and long rates (including the fixed-rate mortgage) have gravitated lower since then.

Great financing conditions supported robust levels of permit issuance (single-family and multifamily) in October, paving the way for strong housing starts in the coming months following a weather-related sag in October. Further, NAHB’s Housing Market Index for November showed a systematic strengthening of builder attitudes toward current and future conditions in the single-family market, and surveys of lenders show that applications for mortgages to buy homes were quite good through the middle of the month. [return to top]

New evidence of stock market impacts on housing . . .
Households have lost massive amounts of wealth in the stock market since early 2000, and such losses ordinarily would take a heavy toll on housing demand. But interest rates fell like a rock in the process, and the terrorist issues that erupted on 9/11 apparently encouraged Americans to place an even stronger focus on hearth and home. The strong housing demand has put substantial upward pressure on house prices, causing homes to become the preferred investment alternative for millions of Americans.

That’s not to say that all parts of the housing market have benefited from the stock market crash and related events. Anecdotal evidence of house price problems at the upper edge of markets around the country has been accumulating, and a recent NAHB survey of builders shows that the stock market decline has taken a significant toll on sales of homes priced above $1 million.

This result is not surprising, in view of the heavy concentration of stock holdings at the upper end of the income and wealth distributions, but such house price issues are not likely to infect the rest of the single-family market. Indeed, our builder survey shows that the stock market decline and the adverse effects at the high end of the housing market have strengthened the lower part of the market. [return to top]

The “soft patch” is the best bet . . .
Chairman Greenspan’s judgment that the U.S. economy has hit a soft patch, and that the economy will strengthen soon (with the help of the November 6 rate cut), is the best bet in an uncertain environment. NAHB’s estimates for the fourth quarter show weak GDP growth (1.1%), slow payroll job growth (0.6%) and a rising unemployment rate (to 5.9%). Our forecasts for 2003 show much stronger performance, along with upward interest rate pressure that is concentrated in the second half of the year. [return to top]

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