- The Washington Times - Tuesday, September 19, 2006

The woes of the housing and auto industries will weigh heavily on the economy this fall and winter, dragging down growth and, some economists say, raising the risk of recession.

News of further deterioration in both sectors hit Wall Street yesterday, tugging on stocks and the dollar as investors fretted about the possibility of a deeper-than-expected economic slump in the United States.

The Commerce Department reported that housing construction plummeted 6 percent to a three-year low in July, while DaimlerChrysler became the third automaker to announce big production cuts in the United States this fall and Ford’s credit rating was slashed to the same level as debt-ridden Argentina.

The serious problems in the two sectors — which are the most sensitive to changes in interest rates because they are heavily dependent on debt-financed sales — are expected to, at the very least, prevent the Federal Reserve from raising interest rates again today and possibly for the rest of the year, Fed watchers say.

“The looming crisis in the U.S. car industry” will be of concern to Fed governors and, with the deepening retrenchment in housing, prompt them to refrain from raising rates again, said Harm Bandholz, economist at HVB Group. The Fed is aware that the two sectors are bearing the brunt of the central bank’s more than four percentage points of interest-rates increases and will not want to do further harm, he said.

News of the stricken auto and housing sectors comes amid signs of an easing in price pressures that should reassure Fed officials worried about inflation and give them further reason to not raise rates, analysts said. Oil prices continued their steep descent yesterday and are down by more than 21 percent from July’s record high. Even before oil’s plunge, consumer and producer prices were starting to ease, according to Labor Department reports.

“In the past couple of months, we’ve watched the growth side, housing in particular, deteriorate faster than anybody expected,” said Gregory Miller, chief economist at SunTrust Banks Inc. “I’m not ready to raise the flag to start calling a recession, but there’s clearly a risk.”

Housing starts, which fell to an annual rate of 1.665 million in July, are 20 percent below levels at the peak of the housing boom a year ago, while permit applications by home builders have dropped for seven straight months — something that hasn’t happened in 20 years. Economists expect the housing slump to be a major drag on growth for months and even years to come.

The housing bust worries economists not only because of the immediate loss of jobs and output. Throughout the housing boom, the rapid growth of home prices fed feelings of prosperity among the 69 percent of Americans who own homes, spawning a “wealth effect” that prompted them to increase spending on a variety of items from home improvements to vacations.

Consumers went deeply into debt, tapping into their home equity to finance a spending splurge estimated at $500 billion or more. Now, that spending spree is expected to slowly come to an end, taking an important prop of support out from under consumers and the economy. Economists think the waning “wealth effect” could be a major factor weighing on growth for years.

The auto production cuts also will eat into economic growth and consumer spending power because of the loss of jobs and income. HVB estimates that production cuts ranging from 8 percent to 21 percent at the Big Three automakers in coming quarters will subtract 1.25 percentage points from the economic growth rate, which had sunk to 2.9 percent in the summer quarter.

Economic growth may average no more than 2.3 percent next year, Mr. Bandholz said. The loss of income and wealth from thousands of auto layoffs will feed into the economy more gradually, he said, but will be pronounced in some Midwestern cities and states closely tied to the auto industry, several of which already have fallen into recession.

Richard Berner, chief economist at Morgan Stanley, said the hazards for the economy are substantial, but he thinks it will withstand the slump in autos and housing.

“Housing activity is in recession, and home prices are decelerating sharply,” he said. “Those trends likely will intensify, paring as much as 1.5 percentage points from U.S. growth in the second half” of the year.

“The plunge in single-family housing construction will cost both output and jobs, and probably will crimp spending on housing-related goods,” he said. “But housing activity and big-ticket durables don’t march in lockstep anymore, and the ‘wealth effect’ is in my view much smaller than the pessimists think.”

Richard Yamarone, economist with Argus Research Corp., said worries about recession are overblown.

“There are plenty of reasons to be optimistic,” he said, citing the economy’s resilience in the face of harsh shocks such as the September 11 terrorist attacks.

He noted that consumers — who fuel two-thirds of economic activity — have not stopped spending in any quarter since 1991, and currently are experiencing a solid job market and expanding incomes. The drop in oil and gasoline prices will only increase their spending power in the months ahead, he said.



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