It's Homeowners vs. Politicians for the Economic Win

The economy might be booming if not for budget cutbacks in Washington.

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In this video image from Senate Television, senators speak on the floor of the U.S. Senate during voting on an amendment to the budget resolution at the Capitol on Washington, Friday, March 22, 2013.

There's a tug of war going on in the U.S. economy at the moment, and a big unanswered question is which side will prevail: a rebounding housing market that's boosting the economy or government austerity that's dragging it down.

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The housing market, at long last, is a positive factor in the economy. This is what usually happens after a recession, except that the housing bust that began in 2006 lasted so long that housing activity didn't become a net contributor to economic growth until last year.

But housing is going strong now. Home prices are rising at an annualized rate of 8.4 percent, according to the most recent S&P/Case-Shiller home price index. Builders are breaking ground again, with more than 300,000 new construction jobs created during the last two years. Fannie Mae and Freddie Mac, the troubled federal housing agencies, have both turned profitable and are sending billions of dollars to the U.S. Treasury.

The biggest impact of the housing turnaround may be psychological. Falling home values wiped out $6.4 trillion of wealth between 2006 and 2011 , according to the Federal Reserve. But now that home values are rising again, lost wealth is being rebuilt, providing a huge sense of relief to millions of homeowners. That makes them more comfortable spending and doing the normal things consumers do.

"Housing will help keep the economy expanding this year and contribute to a stronger economic expansion in 2014 and 2015," Moody's Analytics explained in a recent report.

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The economic recovery, in fact, might be quite strong at this point, except for one thing: budget battles in Washington. Business and households have made many needed adjustments during the last few years, such as paying off debt and streamlining wherever possible. Washington hasn't. The national debt was large before the recession and it exploded during the downturn, leaving policymakers in Washington little choice but to start cutting back, even though the economy is still fragile.

Austerity measures in Washington are now the biggest drag on the U.S. economy. Tax hikes and spending cuts will take about $200 billion out of the economy this year, lowering GDP growth by about 1 percentage point. In a strong economy, that might not matter much, but the economy is still fragile and some economists feel it's a risky time to do anything that might hamper growth.

The effect of those austerity measures has been hard to spot in the real economy, because spending has remained surprisingly strong and the stock market has hit new all-time highs recently. But economists say it's inevitable that the economy will slow at some point.

A weak jobs report for March, when employers added just 88,000 jobs, could be the first sign of a pullback. Some forecasters think the job numbers in April and May will be even weaker. To make up for income lost to higher taxes, many consumers have dipped into savings, which they'll have to rebuild before long.

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CEOs, meanwhile, have been hinting that corporate earnings could decline in coming months as consumers retrench and government spending declines.

The net effect of these competing forces will become more apparent as big companies report their first-quarter earnings during coming weeks. Research firm FactSet noted recently that companies such as Whirlpool and Lennar have cited the housing recovery as a major factor boosting earnings, while companies such as Darden Restaurants and Oracle have voiced concern about the impact of fiscal policy in Washington on their bottom line.

If austerity pushes corporate earnings lower than expected, there will probably be a stock-market pullback, letting everybody know the problem is real. But the housing market will still most likely continue to grind higher. Main Street may ultimately matter more than Washington.

Rick Newman's latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.