They estimated that there were an additional 2.4 million borrowers estimated to be in “near negative equity” where the borrower has less than 5 percent equity remaining. Declining house prices will push these near negative equity borrowers into negative equity. This increases the risk that these borrowers will default on their mortgages either out of necessity – say as the result of a job loss – or out of choice, which is called strategic default as borrowers determine that there is little economic advantage to keep paying the mortgage. Longer delays in the foreclosure process further increase the incentive for a borrower to strategically default by extending the period of time that they can live “rent free” in the house. In addition, declining house prices increase the expected losses on those mortgages that do default. Problems in housing markets can impact economic growth. Housing directly effects growth through incentives for builders to build new houses. Housing starts will likely remain depressed as long as house prices are declining. Falling house prices can also negatively impact consumption growth to the extent that homeowners increase their savings in an effort to offset declines in their housing wealth. The degree to which housing markets deteriorate over 2011 and the impact that this will have on overall growth is hard to predict with any accuracy. The most likely outcome is that the economy will continue to improve as the year progresses despite the ongoing drag from housing.
The concern six months ago was that a soft patch – amid an environment with little room for conventional monetary policy – could be particularly risky. However, growth picked up in the third quarter to an estimated 2.6 percent, and as 2010 came to an end, economists were revising upward their growth forecast for 2011. The risk that the economy will enter a double-dip recession now seems quite low. The increased optimism reflects in part the compromise on the extension of the Bush tax rates, the Federal Open Market Committee’s decision to purchase up to $ billion in Treasury securities, and stronger retail sales during the holiday season. While there are many factors that will affect the shape of the recovery in 2011, a key factor will be the degree of improvement in the labor market. From its peak in December of 2007, employment is down by 7.4 million jobs and remains below its level in January 2000. That is, the “Great Recession” eliminated an entire decade’s worth of job growth (Chart 2). Improved job growth is essential to generating the increase in disposable income that will support continued consumption growth which is so important for overall economic growth. Leading indicators for the labor market are pointing to a likely pickup in the pace of employment gains over the course of this year. Many new hires are preceded by firms posting job openings. According to the Labor Department, at the end of October, there were 3.4 million job openings, up from 2.3 million a year earlier.