Housing Starts: Best and Worst Years

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Interest rates hit an all-time high at this time, approaching 20%, as the Fed tightened monetary policy to control the stagflation that characterized the previous decade. Newly elected President Ronald Reagan supported the Fed's decision, which successfully reduced inflation but thrust the economy into the worst downturn since the 1930s. Reagan, meanwhile, made the largest income-tax cut in American history, and increased defense spending. The unemployment rate increased to 10.8% in 1982, from 7.5% in 1981.

Big Mac Attack

But by mid-1984—the 10th-best year for housing starts on record—unemployment was down to early 1981 levels, and it continued to decrease for the next five years. Reagan defeated Walter Mondale in the 1984 Presidential election with nearly 60% of the popular vote. Also that year, Apple Computer (AAPL) launched the Macintosh with a Super Bowl television commercial called "1984," inspired by the George Orwell novel.

Did people start building 1.7495 millions homes that year to have places to keep their new Macs? Not likely. "You're talking about major up and down cycles," says the NAHB's Seiders.

The current cycle in housing starts is apt to mimic these historical phases, bottoming out sometime in 2007. As always, what happens next depends on the Fed's next move—cutting interest rates in the first quarter of 2007 would help, but only slightly.

Lipsticked Pig

"What's driving housing down today is not so much the level of interest rates but the tremendous increase in the price of housing relative to income," says Paul Kasriel, director of economic research at the Northern Trust in Chicago. The housing affordability index put out by the National Association of Realtors is the lowest it has been since the third quarter of 1986, he notes.

There have been seven housing cycles prior to the current cycle, in the time period between 1959 and the present, and the average peak-to-trough decline of these seven cycles is 47.3%, according Kasriel's research. In the current cycle, housing starts have declined 34% from their peak in February, 2005, to October, 2006, levels. If the peak-to-trough decline in the current cycle were to match the seven-cycle average decline of 47.3%, the annualized pace would need to bottom out at 1.166 million units.

"I think we're going to at least see an average cycle in terms of starts, and housing is going to have a significant ripple affect on the rest of the economy, slowing down employment growth and consumer spending," Kasriel says. "Everybody tries to put lipstick on this pig, but it's a pig."

Sounds like ominous news, but apparently, we've heard it before.

Click here to see the years with the best and worst housing starts since 1959.

Maya Roney is Real Estate writer for Businessweek.com.