Mortgages and the economy Featured

7:00pm EDT December 26, 2007

Burdened by weaknesses in the real estate sector, the economic outlook for the first half of 2008 is sluggish.

The housing sector, however, is expected to rebound later in the year, providing a boost to the economy as a whole.

One of the factors behind the recent real estate slump was the widespread availability of subprime mortgages. These types of loans will be harder and harder to come by in the future, says Comerica’s chief economist Dana Johnson.

“We’re not going to go back to a sub-prime mortgage market that was as wide open and that allowed a lot of reckless behavior on the part of both borrowers and lenders,” he explains. “There is going to be more of a continuing restraint on the purchases of homes.”

Smart Business spoke with Johnson about his economic outlook for 2008, the impact of the subprime mortgage industry and the overall strength of California’s economy.

What is your economic forecast for 2008?

I’m expecting the economy to grow sluggishly this winter and then accelerate over the course of 2008. I’m projecting growth over this winter — the fourth quarter of 2007 and the first quarter of 2008 — to be around 1.5 percent at an annual rate and then accelerate by the end of the year to about a 2.5 percent rate of growth.

The credit crunch has already extended and intensified the recession in housing, and housing is going to be a big drag this winter. All of the turmoil in the credit market will also be a constraint on the economy. For these reasons I think we’re going to have a pretty sluggish pace of growth for a while.

The drag from housing, however, will slow, and we’ll find a bottom sometime in the spring or early summer, and then things will level off or perhaps gradually improve a bit.

How will the meltdown of the subprime mortgage industry affect the economy?

It’s had a very clear and direct impact already in reducing the ability for people to buy houses, which has intensified the pullback in homebuilding and accelerated the decline in home prices. The key issue beyond that is whether the decline in home prices is going to cause consumers to spend more cautiously. So far, there is not much evidence of a big spillover to consumer spending. With consumer spending holding up OK, it looks like the spillover effect has been limited, and this is one of the reasons that I think the overall economy is going to avoid recession.

Foreclosure rates have been especially high in California. Do you believe the housing market will rebound in the upcoming year?

No, I don’t. House prices in California have begun to fall but are still far higher relative to income than anywhere else in the country. It looks to me like there are a lot more adjustments that have to be made in the price of houses in California relative to incomes in California relative to houses elsewhere. California has relied more than any other state on the subprime mortgage market, which is not going to fully recover for years. The adjustments in home sales and prices are going to continue to be very difficult in California all through 2008. We’re talking multiyear adjustments where house prices will not hold up as well in California as they do in other states.

In what ways does the California economy differ from other regions of the country?

The California economy is in many ways a microcosm of the U.S. economy. The distribution of jobs by industry in California looks very similar to the national averages in many respects. There are two areas, however, that look different: It has a leading position in various knowledge-based sectors as well as the life sciences industry.

How important is the health of California’s economy to the United States’ as a whole?

California’s economy makes up approximately one-eighth of the overall U.S. economy, so its health is vital. The California economy is intimately integrated into the rest of the economy; we don’t tend to see the sharp regional differences that we once had. The U.S. economy’s performance is going to look like California’s, and California’s performance will look like that of the U.S. California doesn’t move in lockstep with the U.S. economy but, given its size, its diversity and the fact that the distribution of jobs is so similar to the distribution of jobs by industry in the rest of the economy, what happens in California tends to happen nationally and vice versa.

DANA JOHNSON is chief economist for Comerica Bank. Reach him at (214) 828-5970 or through the bank’s Web site, www.comerica.com.