With Economy Slumping, Can the Housing Market Hang On?

Economic indicators look weak, which could have negative consequences for the recovery.

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We've heard time and time again how intertwined the recovery of the housing market is with the recovery of the broader economy and vice versa. Now with a floundering housing market no longer a dead weight on the economy—analysts expect the industry to add to GDP in 2012 for the first time in seven years—could the reverse happen?

Based on the recent data dump from all corners of the economy, things aren't looking too pretty. All signs point to sluggish-at-best growth for the remainder of the year and still-looming risks such as the European debt crisis and the so-called fiscal cliff are putting even more pressure on an already fragile economy.

Then there's the deceleration in hiring, probably one of the more worrisome potential drags on housing, according to economists. After relatively strong numbers in the first half of the year, job growth has slowed from an average monthly pace of 225,000 in the first quarter to a measly 95,000 in recent months.

[Read: August Existing-Home Sales Beat Economists' Expectations.]

"The bottom line is, robust growth in housing will depend on job growth," says Doug Duncan, chief economist at Fannie Mae. "Job growth will generate income growth and then you'll start to see more households start to form and the pattern will accelerate."

"It really is all tied to the prospect of job growth," Duncan adds.

But even with projections for future job growth shuttered, Duncan doesn't expect a doomsday scenario. Barring disaster in Europe or an unsavory resolution to the fiscal cliff—the expiration of Bush-era tax cuts paired with severe budget cuts agreed to as part of a debt-ceiling deal—most economists don't anticipate a double-digit drop in property values.

"Prices appear to have stabilized broadly—not in every market, but on average across the country," Duncan says. "You could create a scenario where [severe price drops] occurred—if the fiscal cliff wasn't resolved, you could see a recession in the U.S. economy compounded by what's going on in Europe."

But even if we're not likely to see a reprise of the massive price drops seen a few years ago, everything isn't just smooth sailing for housing. As Duncan puts it, housing is a "relative" bright spot but by no means "robust." At this point, the relative strength in housing is compensating for some of the weakness in the broader economy, but high gas prices and drought-fueled increases in food prices could curtail the rising tide in housing.

"We're on the right track," Duncan says. "We are telling people not to get overly excited on either side of the owning and renting [equation]. We're watching a rebalancing of the relationship between owning and renting. We're coming down to more rational levels of homeownership."

[Read: Pace of New Home Building Surges to 2-Year High.]

That means if the economy does take a detour south, it's not the end of the world. We could see modest price declines, some experts say, but most of the strength in housing we've been seeing is due more to the housing market correcting itself from abysmal bottoms than a bubble waiting to burst again.

"Seriously bad economic news would hurt the housing market, no question," says Jed Kolko, chief economist at real estate information website Trulia. "But even if we see modest declines in prices, we have seen that when prices fall we get strong demand from investors [here] and foreign investors."

Furthermore, if housing demand abates, we're not stuck with as large a glut of supply this time around, he says. Total inventory of homes for sale is currently around six months, a more historically normal level.

But while the lingering economic slump in the latter part of this year might not mean be a TKO for the housing market, it could make things more difficult for people already struggling to purchase a house. Amassing enough cash for the higher downpayment requirements these days would become more of an obstacle and would-be buyers could have to take on more debt.

Still, the rock-bottom low interest rates continue to be a boon for buyers and Kolko expects rising prices to continue through the end of the year, which could help more folks out when it comes to the negative equity issue.

"The price increase we've seen reducing negative equity probably didn't have much to do with policy and are more about the markets rebounding," Kolko says. "The recovery we're seeing now is the housing market correcting itself."

Meg Handley is a reporter for U.S. News & World Report. You can reach her at mhandley@usnews.com and follow her on Twitter at @mmhandley.