The global driver: how housing is driving the world economy.

• Author: Hale, David
• Position: Residential real estate affecting economy

One of the most remarkable features of the world economy today is the role of housing inflation in driving the growth rates of the leading English-speaking countries.

Housing has played a major role since 2000 in shaping the business cycles of the United States, Britain, Australia, New Zealand, Canada, and South Africa. In the five years through 2004, house prices rose 182 percent in South Africa, 102 percent in Britain, 78 percent in Australia, 65 percent in New Zealand, 50 percent in Canada, and 50 percent in the United States. The housing boom has produced negative savings rates and higher consumer spending in the United States, Australia, New Zealand, and Canada. Weakness in house prices has recently produced a downturn in consumer spending in Britain and Australia. The United States continues to enjoy healthy gains in retail sales because house prices are still rising at double digit rates despite a year of monetary tightening.

The U.S. Federal Reserve will continue hiking interest rates because of the impact of housing inflation on consumption and concern about the market becoming overly speculative. The market value of residential real estate in the United States is now equal to nearly 200 percent of personal disposable income compared to 160 percent during the early 1990s. The dollar value of existing home sales now exceeds 16 percent of personal income compared to 8-10 percent during the late 1990s and a previous peak of 12.5 percent during the late 1970s. Mortgage-related assets are now equal to 61 percent of bank credit compared to less than 50 percent ten years ago and only 25 percent during the 1970s.

The Federal Reserve may also introduce new guidelines for mortgage lending in order to curtail high-risk forms of lending aimed at helping home buyers cope with appreciating house prices. The U.S. housing market now has forms of lending that have not existed since the 1920s. In California, two thirds of new mortgage loans now require interest repayments only while many loans have low teaser rates in the first year. Business Week recently conducted a survey of over two million mortgage loans and found out that 95 percent of the purchase price was borrowed in 38 percent of the loans made this year compared to 34 percent last year. The subprime component of the mortgage-backed securities market nearly doubled in 2004 to reach $401 billion, or 21 percent of mortgage-backed issuance.

Central banks do not ordinarily target house prices...