You have to have a view on housing -

You have to have a view on housing to make any macro decisions. In a word, the housing market is bad. But everyone already knows that information. Now the issue is the impact of a bad housing market on the US overall and world economy. When you start looking at residential housing as a portion of GDP and household wealth, the story gets more complex. A recent speech by Bill Poole, president of the St Louis Fed, provides good background information on this issue.

http://www.stlouisfed.org/news/speeches/2007/10_09_07.html

Some facts:

The value of residential real estate is just over $20 trillion and mortgage liabilities are worth about $9.8 trillion which means that the net value of residential real estate is close to $11 trillion dollars. The net value of the assets is positive. Now, there will be spillover effects from a decline in housing from defaults, foreclosures and forced liquidation, but the value of housing is a positive contributor to household wealth.

Yet, the value of residential real estate is only half the value of financial assets for each household. While for many a home is their leading financial assets, overall, household net worth is tied to cash, equity, and bonds through savings and retirement accounts. The non-housing portion of household wealth is double the net value of housing. There is a wealth effect from changes in the housing stock, but the impact may not be as immediate as many would expect given all of the subprime stories in the newspapers. Lower wealth will affect consumption but the link is not as direct as many may expect.

Residential construction represents about 30% of total private investments. Nonresidential construction is approximately 20%. There has been an increase in nonresidential construction since the peak in the housing market. The declines in residential investment have been offset by gains in the nonresidential area. While these offsets are not one for one, the investment sector has been cushioned by growth outside residential construction.

Construction represents about 7.7 workers but is still just over half of the number of workers in manufacturing. Health and education are also much larger sectors for employment. Construction is 5.5% of total non-farm payroll, so a loss of a significant portion of these jobs may not have a significant impact on overall employment if there are strong gains in other sectors.

Housing usually peaks before he beginning of a recession. On average it leads a recession by three quarters. Clearly, this time between the housing turndown and the decline in growth of the overall economy has been delayed. This delay is what is unusual for this business cycle. The size of this decline dwarfs many previous housing cycles but the run-up was also greater.

The impact -

These facts do not minimize the hazard faced from a housing credit problem, but some of the effect has been and will be muted by growth in other areas of the economy and by the mix of assets held by households or their net worth. Spillover effects across sectors are significant and the hardest to measure. For example, the hosing decline has had a high impact on equity values for retailers.

The impact on employment may be muted because of potential gains from manufacturing which is a larger sector than the construction area. A slow growth scenario in the US is most likely if the subprime problem can be muted.

Unfortunately, monetary policy cannot be focused on only the housing market. The continued lowering of interest rates to help the housing markets will also have spillover effects in other areas of the economy and on the international side through its impact on the dollar. These spillover effects may have a greater impact than contagion from housing.

These spillover issues will be driving Fed behavior at their meetings this week.