Falling construction will lead to a large drop in 4th quarter GDP.

    The National Association of Home Builders' housing market index fell to a new low of 9 in October, dropping 5 points from the September level. The Census Bureau reported that housing starts dropped 4.5 percent in October to an annual rate of 791,000. Construction of single-family homes fell by 3.3 percent to a 531,000 annual rate. The construction rate on single-family homes is the lowest since October of 1981, when it was at a 523,000 annual rate. The overall rate is the lowest since at least 1959.

    The sharpest falloff in starts in October was in the Northeast, where they declined by 31.0 percent from the September level. The decline was entirely in multi-unit structures as there was no change in starts in 1-unit structures. Starts of 1-unit structures in the Northeast are down 40.6 percent from their year ago level, while starts in multi-unit buildings are down 51.6 from year ago level. While the Northeast has experienced the sharpest drop in starts over the last year, this is mostly due to the fact that starts had held up better in the region through 2006 and most of 2007.

    The fall-off in building permits was even sharper than the decline in starts. Overall permits fell by 12.0 percent, with permits for 1-unit structures falling by 14.5 percent. The sharpest decline in permits was also in the Northeast, with overall permits down by 23.7 percent from the September level and by 51.0 percent from October of 2007.

    The drop in permits for single-family homes was somewhat less steep, 16.4 percent compared with September and 39.5 percent compared with November of 2007. The South saw the next sharpest drop in permits, with an overall decline of 13.5 percent compared with September and a drop of 14.4 percent in permits for single-family homes.

    The sharp decline in permits is noteworthy since it likely indicates that builders are having difficulty getting credit. This is another case where business problems due to a fall in demand can wrongly be attributed to a credit crunch. Most builders have taken large losses in the last two years. With record inventories of unsold homes and rapidly falling house prices, there is little prospect in most areas of making substantial profits on new residential units. Given these conditions, even well-capitalized banks would be reluctant to make loans for new construction. The problem is the condition of the housing market, not access to credit.

    There is no reason to think that the housing market will turn around any time soon, although the continued decline in starts is a good sign from this vantage point. The enormous over-supply of homes on the market will be absorbed more quickly if builders stop adding to the inventory.

    However, there will continue to be large numbers of homes put on the market through foreclosure and other distress sales. The pressure from this direction is likely to worsen in the months ahead given the sharp jump in job loss that we have seen the last two months. There may be important questions about preventing a downward spiral of house prices as falling prices lead to more foreclosures while at the same time reducing the number of potential buyers by destroying home equity. Unfortunately, it is not possible to have a serious discussion of appropriate policies to stabilize prices without distinguishing between bubble and non-bubble markets, something that policymakers and economists find difficult to do.

    The data on starts and permits suggest that residential construction is likely to continue to slow in the months ahead. The decline in residential construction subtracted 0.72 percentage points from GDP growth in the third quarter. The data on starts and permits suggest that it may have a comparable effect on 4th quarter GDP. With non-residential construction also falling, and consumer expenditures likely to show a sharp decline and the big jump in defense spending likely to be reversed, the 4th quarter may show one of the worst growth figures on record.