Four Reasons Housing Recovery Isn’t Yet Boosting Economy

The housing market may finally be leaning on the economy’s gas pedal—but it’s also keeping a foot on the brake. Those expecting a quick return to the “virtuous cycle” by which rising prices, home sales, and housing construction feeds further consumer spending will have to wait until Americans feel more comfortable borrowing and until banks feel more comfortable extending credit, according to new commentary published by  analysts Joshua Anderson, Emmanuel S. Sharef, and Grover Burthey at Pacific Investment Management Co., or Pimco, a unit of...

The housing market may finally be leaning on the economy’s gas pedal—but it’s also keeping a foot on the brake.

Those expecting a quick return to the “virtuous cycle” by which rising prices, home sales, and housing construction feeds further consumer spending will have to wait until Americans feel more comfortable borrowing and until banks feel more comfortable extending credit, according to new commentary published by  analysts Joshua Anderson, Emmanuel S. Sharef, and Grover Burthey at Pacific Investment Management Co., or Pimco, a unit of Allianz SE.

The Pimco strategists outline four primary blockages that could restrain the housing sector’s ability to play the traditional role boosting the economy during a recovery.

First, construction is coming back, but the industry’s muscles have atrophied a bit. It could take a while for the housing-construction industries to rebuild lost muscle mass. While builders started construction on 780,000 units last year, an increase of 28% from the year before, construction still needs to double to keep up with population and household growth.

How quickly it gets there matters, and the speed with which construction grows could depend on its ability to overcome a series of capacity constraints. The housing crash “disrupted the process of entitlement and permitting of vacant land, while the construction labor pool shrank as unemployed workers left the labor force, re-trained into other industries or emigrated,” the Pimco report says. “The construction labor force is now smaller than it has been at any time since 2000, and it is unclear whether large pools of skilled labor can be easily tapped to build 1.5 million units.”

Second, banks have to be willing to expand credit beyond today’s conservative standards. New regulations will keep lenders cautious. Ironically, rising rates could help, because that will dry up the gravy train of refinances that have kept mortgage lenders well fed over the past two years. With less refinance business, banks will have greater incentives to compete for business, easing up their standards.

Third, consumers also have to feel confident enough to borrow. Because government spending cuts will further crimp spending, especially among “already stretched lower- and middle-income consumers,” the Pimco analysts argue that “any tangible impact from reduced savings will likely come from earners in the top 40%, who are also more likely to be homeowners and hold over 70% of consumer credit.”

The top 10% of all households have seen their net worth grow, in part because more expensive properties saw less dramatic price declines. So what about those in the next 30%? Mortgage debt has fallen, but mostly through default. Although home prices have gone up over the past year, the most substantial gains have accrued in areas that saw big declines in home prices. In that sense, rising home values are, for now, simply restoring lost equity and not creating new wealth.

Fourth, mortgage-equity withdrawal—the process by which homeowners take cash out of their homes—isn’t likely to play the same role that it did during the past decade in fueling consumer spending. This is true both because lending standards are more conservative today, and also because equity extraction was an aberration during the heyday of the housing boom.

During 2012, homeowners extracted around $65 billion from their homes—far less than the $209 billion that was extinguished either through amortization or default. Pimco forecasts that mortgage debt outstanding will continue to decline by around $30 billion through the middle of next year, before gradually increasing throughout 2015.

The upshot, the analysts say, is that despite grounds for being optimism about housing, its effects on stimulating consumption and economic growth is likely to be postponed. “The transmission mechanism between home prices and spending depends on lending growth, which is likely to stay low for some time,” they write. “As a result, the new period of reduced government spending, the consumer’s ability to take the baton is delayed.”