U.S. Economy Faces Trouble from Falling Housing Market
February 8, 2008
As the United States prepares to elect its next president in November, candidates are facing tough questions from citizens frustrated with the state of the U.S. economy. Many voters say that they will base their decision largely on economic matters and will vote for whichever candidate seems most capable of turning the economy around. The eventual winner will have a difficult time fulfilling civilians’ expectations and transforming the national economy.
In past months, an increasing number of economists have voiced concern that the United States may be heading toward a recession. Technically, the country is not currently in a recession. Professor Daniel Richards of the Economics Department at Tufts writes that “an official recession is when the economy’s output fails to grow for at least two quarters (six months).” The country’s gross domestic product (GDP) growth began to slow down at the end of last year but so far, the decline has not persisted long enough to constitute an official recession.
Many Americans are unconcerned with official labels and are simply frustrated with current situation. They do not care if the nation is officially in a recession or not; all they know is that their lives are now more difficult as a result of the struggling economy. Indeed, signs of a downward trend are evident in all sectors of the economy. The decrease in GDP means that there is less production and thus less demand for workers. As a result, the national unemployment rate has risen, peaking in December, 2007 at five percent. Some cities have experienced even higher increases in their unemployment rates; in December the New York Times reported that there were 7,655,000 unemployed New York City residents, a 13.2 percent increase from the previous year.
The weakening power of the U.S. dollar abroad is another sign of the struggling economy. For the past several years, the value of the U.S. dollar has fallen steadily in comparison to other foreign currencies, especially the Euro and the Canadian dollar. Professor Richards explains that the decline in the value of the U.S. dollar reflects a combination of forces. “First, over the last six years or so, the borrowing by households coupled with the borrowing by the federal government (thanks largely to the Bush tax cuts of 2001) means that the U.S. as a whole has had to borrow a lot from the rest of the world. That borrowing means we’ve given the rest of the world a lot of paper IOU’s denominated in dollars,” he said. Currently, many foreign investors are trying to cash in their dollar assets because the U.S. economy is slowing. This intense demand for cashing in IOU’s is driving the value of the U.S. dollar down and reflects the declining state of the U.S. economy, especially in relation to other global economies.
Analysts are now trying to determine why consumers are spending less today, and thus driving the GDP down. This decrease in consumer spending is largely due to the struggling housing market and Americans’ poor borrowing habits. According to Richards, consumer spending on goods and services did not slow down in the past several years because “consumers have borrowed heavily to sustain that spending.” As a result, the number of households in debt has certainly increased in recent years. “About 18% of household disposable income now goes just to pay interest on outstanding debt – that’s about three percentage points more than in 2000.”
Interestingly, this extraordinary debt has not prevented Americans from spending until very recently. In the past, high consumer spending was supported by a robust housing market. While the average consumer’s take-home pay wasn’t rapidly increasing, the value of their house was. Therefore, taking on an extra $200,000 in debt, for example, did not seem to be as much of a burden if the value of their house had risen by $300,000.
The downward trend in the housing market is the primary cause of the decrease in consumer spending. For much of the 1990s and early 2000s, the price and value of households rose. Families felt secure knowing that they could sell their house for a good price, so they didn’t worry about spending a lot on consumer goods. But now, house prices are declining. Professor Richards notes that “the housing bubble has burst – people are buying homes less frequently and that means that if you want to sell you have to do so at a lower price. Home prices fell for the entire 12-month period of 2007 for the first time in 40 years.” The Boston Globe reported that in November, 2007, sales of single-family homes in Massachusetts dropped over 15% from the previous November and that the prices for both condominiums and single family homes were down. Many families, no longer certain that they can sell their homes for a comfortable profit, are growing increasingly uncomfortable with the large debts they have accrued. For this reason, many families have chosen to cut back on spending in order to repay debts and save for the future. “When all the debt that households have accumulated is combined with the loss in home values,” explains Richards, “many [people] are going to cut back their expenditures and try to rebuild their savings. When enough people do that, though, consumer spending drops and so does GDP.”
In recent weeks, the government has enacted a number of measures designed to improve the economy and help the American public. On January 22, 2008, the Federal Reserve issued a three-quarter-point interest rate cut, the largest single-day rate cut in the agency’s history, in an effort to boost investment and expenditures. A second cut of half a point followed eight days later. According to Richards, “an important reason that people stop spending is because they cannot get credit to finance their spending or can only get it at very high interest rates. Reducing those rates should make it easier for households to continue spending and thus avoid recession.”
The President and the U.S. House of Representatives have recently reached a tentative agreement on a $150 billion economic stimulus package designed to give more money to consumers The package would provide stipends, or tax rebates, of between $300 and $1200 to more than 100 million American households, as well as provide tax incentives for businesses. The goal of the package is to provide more money to citizens and businesses so that they can spend more on goods and boost the economy.
While many lawmakers and civilians praise the package, other analysts contend that it does not do enough to alleviate the problems with the economy and will not have a significant effect. According to Richards, “the one group of people who would spend most of that money now are people who are really up against it – people who are unemployed, or so poor that they qualify for food stamps, etc. Unfortunately, the tax cut stimulus package gives most of its benefits to people who are high in the income distribution, e.g., small business owners.”
Some senators agree with Richards and insist that the package should extend unemployment benefits and increase money for food stamps. Senator Max Baucus, Democrat of Montana and the Chairman of the Finance Committee, has proposed an alternate $160 billion package that would extend unemployment benefits, provide more tax relief to seniors, and provide heating assistance for the poor, among other things. According to the Boston Globe, the U.S. Senate is expected to pass Baucus’ alternate package, while the House is on the brink of approving the original package, setting the stage for fierce negotiations between the two bodies. Only time will tell if such measures will succeed in boosting the economy and preventing a recession. In the meantime, Americans are trying to adjust to these tough times, and are looking to the presidential candidates for hope for the future.