Home Building Industry: Economy, Interest Rates & Reform

The Home Building Industry and the Broader Economy

A number of factors facing home builders affect the home building industry in ways unique to this sector — ways that most other industries never have to contend with. On the reverse side, however, the home building industry also affects the economy and job markets more than almost any other industry. Researching the components of the home building industry should therefore take into account the position assumed by such an influential sector.

One of the most prevalent characteristics of the industry is its close link to the investment community. The Federal Reserve and Wall Street keep a close eye on what is taking place within the industry at all times, and the Fed has been known to act directly in response to housing market conditions — a fact that underscores just how central homebuilding is to the overall health of the U.S. economy.

Federal Reserve Policy and Housing Market Stability

In the lead-up to and during the 2007 housing crisis, the Federal Reserve lowered key interest rates to allow more money into the banking system in an attempt to ease constraints on mortgage lending and the capital needed by home builders to construct homes. This action was taken in direct response to hardships being faced by the home building industry.

An August 2007 article in the USA Today Money section noted: "Fears that lenders have been tightening the cash spigot have been troubling stocks for weeks. The Fed's decision, though, to leave its target for short-term interest rates untouched and the lack of serious concern in its statement removed some of the panic" (Fed's Calming Outlook, 2007, p. 1B).

That action may have removed some of the panic, but it did not fully alleviate the situation. The Fed came out with even stronger language concerning the housing market less than a month later. As the Economist reported: "Ben Bernanke, the Fed chairman, did his statesmanlike best to exude confidence, reiterating that although the central bank should not protect lenders and investors 'from the consequences of their financial decisions,' it would act 'as needed' to limit damage to the broader economy" (Tangled Reins, 2007, p. 80). Shortly thereafter, the Federal Reserve lowered interest rates in order to shore up the shaky industry — not only to assist the home building sector specifically, but also to quell any carryover effect into the equities market and the economy in general.

The action illustrates the importance the housing market holds in maintaining a strong economy. The Fed uses interest rates to stimulate or curtail growth depending on how fast or slow the economy is moving. As one analyst summarized: "Rates typically have the largest influence of any factor driving home sales, based on their effect on mortgage payments and income needed to obtain a mortgage" (Stovall, 2004).

Interest rates are therefore imperative to a housing industry that serves as one of the key variables in predicting how the rest of the economy will perform. Whenever housing markets suffer, the broader economy tends to suffer as well. A clear illustration of this dynamic was the key interest rate cut of 0.5% made by the Fed at their September 2007 meeting. Many experts had anticipated a rate cut, but few had predicted a reduction as large as 0.5% — most were forecasting only a 0.25% cut. The equities market responded the very next day with a resounding gain and continued to climb, with very little setback, in the weeks that followed. The credit market in particular showed a rebound from its previous doldrums.

The 2005–2007 Housing Decline

The situation in the home building industry during this period stood in stark contrast to the early part of the twenty-first century, when housing was booming and builders could not construct homes fast enough to meet demand. Toward the end of 2005, many economists were already sounding warnings about an impending slowdown.

As early as late 2004, S&P's Sector Group Head for Industrials and Materials, Michael Jaffe, believed: "Technicals aren't the only reason to think that this group has seen better days — the fundamental outlook also is negative" (Stovall, 2004). Jaffe was not alone in his skepticism. The market continued at a somewhat even keel into 2005 but then began to falter.

2006 was a year that many builders, investors, and money managers would like to forget, and the decline continued into 2007: "The decline in the stocks of the home building industry in the U.S. after a batch of poor quarterly financial results and new economic data reinforced investors' concerns about a deepening slump in the U.S. housing market" (Bogoslaw, 2007, p. 15). After a year and a half of steady declines in housing values, rising mortgage defaults, and a deepening credit crunch, the housing market needed a boost, and the Fed responded by cutting rates.

Conclusion: Housing as an Economic Indicator

The home building industry appears to be one that can provide the economy with a boost when needed, offering a stable foundation at all times and overall growth that can lead to a robust job market, expansion in GDP, and financial independence for builders willing to commit to the hard work required to succeed. Relatively few industries offer individuals that type of opportunity, and even fewer continue to exert the financial and market influence that the housing industry displays.

It is difficult to determine whether the economy exerts more influence on the housing market or the housing industry exerts more influence on the economy. Both play a key role in the public's financial perception of economic conditions. When the housing market is strong, it signals that buyers believe the economy is robust enough to support a home purchase. When it is weak, the reverse holds true. Hand in hand, the housing market and the broader economy paint a picture of what life in the future will look like, based on conditions in the present. Sometimes that picture is bleak — and sometimes it is decidedly rosy.

Works Cited

Bogoslaw, D. (2007). Homebuilders in a hole. Business Week Online, p. 15.

Fed's calming outlook bucks up stocks. (2007). USA Today, Money Section, p. 1B.

Patterson, R. (2005). Home sour home. Mother Jones, 30(4).

Stovall, S. (2004). Homebuilders: A slump after the jump. BusinessWeek Online.

Stover, D. (2006). Building blocks. Popular Science, 269(5), pp. 79–124.

Tangled reins. (2007). Economist, 384(8545), p. 80.