When the Walls Come Tumbling Down

Editor's Note: This column by Doug Kass is a special bonus for TheStreet.com and RealMoney readers. It first appeared on Street Insight on Aug. 9 at 7:58 a.m. EDT. To sign up for Street Insight, where you can read Kass' commentary in real time, please click here.

Our house is a very, very, very fine house
With two cats in the yard
Life used to be so hard
Now everything is easy, 'cause of you
I'll light the fire
While you place the flowers in the vase that you bought today.

-- Our House, Crosby, Stills, Nash & Young

At the core of my economic concerns for 2006-08 is the swift and deep deterioration in the U.S. real estate market.

Housing has been -- to paraphrase New York Yankee slugger Reggie Jackson's self-description -- the straw that stirs the drink of the consumer and the economy.

The construction industry has been the most important catalyst for economic growth since 2001. The Federal Reserve took interest rates to unprecedented low levels, and mortgage lenders encouraged activity through creative mortgages, which kept mortgage debt service even lower by requiring small monthly payments.

Indeed, economists at Merrill Lynch (and elsewhere) have pointed out that residential and nonresidential construction activity was responsible for nearly half of GDP and employment growth since 2001.

Equally important, the unprecedented rise in home prices (especially of a coastal nature) buoyed consumer confidence, allowed the consumption binge to be extended (through record refinancing cashouts) and encouraged consumers to stop saving (comfortably relying instead on the appreciation of their homes).

On The Edge, I argued -- prematurely -- that the housing cycle was no different than past cyclical experiences and that the long boom forecast by industry participants (homebuilders and analysts) was fallacious and, in the fullness of time, housing activity and prices were headed for a fall.

The major reasons for my forecast were twofold and differed from the declines of the past (which were influenced by job losses and other negative macroeconomic forces). Affordability (home prices divided by household incomes) had been stretched to levels never before seen, and a new class of buyers (speculators or daytraders of homes) had artificially inspired rising home prices (very similar to daytraders of stocks in the late 1990s).