How bad can a US downturn possibly get?

That is a good question and I would like to know the answer. Luckily the people over at The Financial Times has an article with the same title...

First, the good news. The US housing slump is unlikely to drag the US economy down very much. It is true that up to now, the major source of weakness in the US economy has been the housing sector. At the end of Q2, 2007, the Federal Reserve Board reported the market value of the US residential housing stock $21.0 trillion and single family mortgage debt at $10.1 trillion. About 14 percent of the mortgage debt, $1.3 trillion, say, is sub-prime. According to the Case-Shiller data, since the end of 2006, the average US house price may have fallen by 5 percent or so, knocking about one trillion dollars of the value of the US housing stock. The brain behind these data, Bob Shiller of Yale University, believes a further decline, over a period of years, of 15 percent is in the cards.

The reason for the good news is that there is no first-order wealth effect from a change in house prices on private consumption; a decline in house prices is a redistribution from home owners to consumers of housing services, that is, from landlords to renters.

Then a lot more details...

The major source of demand strength is the US economy is the external sector. This is not surprising, as the rest of the world is growing faster than the US and the real effective (that is, trade-weighted) exchange rate of the dollar has dropped like a stone. Exports are a much more important source of demand in the

US (12.0 percent of GDP in 2007Q3) than they were in 1975, for about 8.5 percent of GDP or in 1965, when they were 5.2 percent of GDP. From its peak in 2002Q1 the broad effective real exchange rate of the US dollar had depreciated by 25 percent by 2007Q3. The precipitous decline of the nominal and real exchange rate of the dollar since September can easily have added another 5 percent to the cumulative real depreciation rate. In real terms, the dollar today is as weak as it has been at any time since 1970.

And a lot more details...

Here is a link to the blog entry...