Will the housing recovery survive Hurricane Sandy?

When the Commerce Department recently announced that new home construction was up strongly in September of 2012, the news was widely hailed as a sign that the economy was gaining strength. The reality may not be that simple.

It should be clear by now that this is no ordinary economic cycle, and under the circumstances there are both positives and negatives to the recent housing trend, not to mention a significant wrinkle in the form of Superstorm Sandy. So, in terms of how a rise in new home construction might affect the economy, take a look at the following breakdown of the pros, cons, and that troublesome wild card, Sandy.

Housing recovery pros…

The Commerce Department announced that new housing permits were up 11.6 percent from August to September, and 45.1 percent over the prior year. New housing starts were up 15.0 percent from August to September, and 34.8 percent year-over-year.

Those are impressive gains, and here are some of the prominent arguments for why this bodes well for the US economy:

1. Home building is a sign of optimism. The decisions to build these houses were not made in isolation; presumably, developers assess the economic environment around them and act accordingly. The surge in new housing activity suggests that builders are picking up positive signs on their local economies.
2. New construction creates jobs. Isolated signs of growth are less important than trends that can make growth sustainable. Home construction is labor-intensive, and thus can create new jobs. Putting more people back to work is the type of thing that builds sustainable growth, as those newly-employed workers now have more money to put into the economy.
3. There is a secondary benefit to new home sales. The positive carry-over from new home construction does not end with putting home builders back to work. Typically, when people occupy new homes they enter a phase of new spending to furnish those homes, spreading the economic benefit to other industries.

and cons…

The above are all good reasons why new home construction is traditionally interpreted as a good indicator of economic strength, but unfortunately, this is not a traditional economic cycle. There are some aspects of the current economic environment which make the sudden surge in new residential construction activity a little troubling.

1. This may be more bubble than bounce. Ultimately, it is selling homes that counts, not building them, and it remains to be seen whether demand for housing can justify a sudden flurry of new building. Otherwise, new construction is just a sign of speculation rather than recovery. In fact, home prices have only recently started to bounce back a little; it would be a shame to see that recovery derailed by a new wave of over-building.
2. This could hurt existing home values. Even if there is demand for newly-built homes, new construction at a time when there is an excess inventory of existing homes on the market could hurt the prices of those existing homes by diverting demand away from that sector of the housing market. This would mean more home owners stuck with under-water mortgages and thus unable to refinance.
3. Consumer credit may not be able to support a new housing boom. Yes, lower interest rates have made debt burdens more manageable, but Federal Reserve figures show the level of consumer credit outstanding to be at an all-time high. This hardly suggests Americans are in a good position to obtain the financing necessary to support a new wave of home buying.

...plus Superstorm Sandy

A new twist to the already-complicated housing story arrived in late October in the form of Hurricane Sandy. The devastation caused by this superstorm could have both stimulative and restrictive impacts on the economy. For example, it will put many people in the construction trades to work, but diverting resources to rebuilding could slow the trend of new construction. Also, while people in some trades benefit, others might find themselves out of work -- temporarily or permanently -- because many businesses are shut down. Finally, as the storm's damage increases demand for some materials and constricts supplies of others, it could add to inflation pressures.

Will the pros overcome the cons, and can the hazards of the wild card be avoided? Time will tell, but the three keys to watch are:

1. Whether employment growth improves
2. Whether home prices continue to regain strength at an orderly pace
3. Whether inflation can be kept under control

Accomplishing all three would be a neat trick, but that's exactly the type of difficult feat this economy needs to pull off to escape the doldrums.