THE US is headed for a recession that could be much nastier, deeper and more protracted than the one witnessed in 2001, warns the President of the Roubini Global Economics and a former senior economist at the White House and US Treasury, Nouriel Roubini.

While the 2001 recession was the result of a “tech bust”, Roubini says the 2007 recession will be caused by the biggest housing slump in the last four or five decades.

July 2006 did not prove auspicious for the US real estate market, as sales of existing homes dropped in the month by 4.1 per cent to a two-year low, prices stagnated and the inventory of marketable homes jumped to a 13-year high. Market analysts are of the view that the market has not hit the bottom yet and that the sales would continue to decline through 2007.

It is feared that the bursting of the housing bubble would affect every household in America, not just the limited number of people who owned shares in technology companies during the dot-com boom in 2001.

The housing sector is extremely important in the US economy. The unprecedented increase in housing prices in the recent past had led to a boom in housing construction and sales. In 2005, new construction was about 50 per cent higher than a decade earlier. Sales of existing homes in 2005 were nearly twice the sales in 1995.

The surge in housing construction and sales led to a massive employment growth in the housing and related sectors, which accounted for nearly five million jobs. During the last decade, house prices rose by more than 50 per cent after adjusting for inflation. This created an estimated $5 trillion in housing bubble wealth. Consumers borrowed more than $600 billion against this new wealth, which is said to have fuelled the consumption boom of the last five years.

Now, if the housing construction and sales fall back to normal levels – as there is already a housing glut – it would mean a loss of nearly two million jobs. Besides, the drop in consumption resulting from the inability of people to borrow against their homes would hit the economy. At the same time, the financial system may also been adversely affected due to an expected rise in mortgage defaults, since millions of people may face difficulty in continuing their mortgage payments.

The present housing slump, by itself, should be enough to spark a US recession, because of its effect on wealth, consumption and employment. However, there are at least two other factors which will contribute to pushing the US economy into recession in the coming months.

The first of these factors is the higher price of oil. It may be recalled that international oil prices stood around $20 a barrel, nearly four years ago. The same, however, crossed the $78 a barrel mark on July 13, after Israel’s attack on Lebanon raised fears of a wider Middle East conflict and possible disruption of oil supplies.

During the past few weeks, the international oil prices have again declined to $62-63 a barrel. However, the price is still more than three times the prices prevailing four years ago. Higher oil prices have pushed up the production costs and reduced the buying capacity of consumers. A decline in aggregate demand obviously hits consumer spending, production and employment growth, thus paving the way for an economic downturn.

Another factor is the rising interest rate. The US federal rate stands at 5.25 per cent. Due to fear of inflation, the US Federal Reserve has been raising the federal rate at regular intervals.

Although higher interest rates help in combating inflation, they also lead to an economic slowdown by increasing the cost of doing business. US analysts have expressed the view that ‘the deadly combination of three ugly bears (slumping housing, high oil prices and rising interest rates)’ is going to pave the way for a recession.

The sales of consumer durables such as cars and furniture in the US are already falling. Auto giant Ford was reportedly cutting 20 per cent of its production and industry analysts expected GM and Chrysler, also, to make similar production cuts in the coming weeks and months. Market analysts are of the view that a drop in car sales is one of the strongest indicators of recession.

According to these analysts, if sales by new-car dealers decline by two per cent or more over 12 months, compared to the 12 previous months and adjusted for inflation, then a recession is either underway or set to begin within a few months The figures released by the US Census Bureau showed a decline of 2.4 per cent in sales.

A recession or economic slowdown in the US – the largest economy in the world – is likely to have some adverse effect on the global economy. The US being the major export market for Pakistan, our exports, industrial production and employment growth may be adversely affected in the event of an economic downturn in the US. Pakistan should be fully prepared for any such eventuality.