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Federal Reserve Chairman Ben Bernanke expressed more optimism about the economy in his most recent testimony Friday to the Senate Budget Committee, while also defending the Fed’s controversial plan to buy an extra $600 billion in government bonds to keep recovery moving forward.

Bernanke predicted a “moderately stronger” overall pace for the economy in 2011, noting the Fed has seen “increased evidence that a self-sustaining recovery” is occurring.

He cited improvements in consumer spending and a drop in jobless benefit claims as signs of recovery. However, he said it would take four to five years for the labor market to return to normal unemployment levels. The U.S. jobless rate dropped to 9.4 percent from 9.8 percent last month, but he noted the decline was partially due to a number of people leaving the workforce.

In his testimony to the Senate Budget Committee, Bernanke defended the Fed’s controversial plan to purchase $600 billion in government bonds, a move he says will boost the economy by lowering interest rates and encourage spending.

“Doing nothing will not be an option indefinitely,” Bernanke told the Senate Budget Committee. “Diminishing confidence on the part of investors that deficits will be brought under control would likely lead to sharply rising interest rates on government debt, and, potentially, to broader financial turmoil.”

Source: “Bernanke Grows More Confident in U.S. Recovery,” Reuters News

“It is ironic, but there is a growing consensus that there may be a new housing shortage coming,” said James Gaines, a real estate economist with Texas A&M.

“A housing deficiency isn’t a sure thing, but the potential is certainly there.” says David Crowe, chief economist at the National Association of Home Builders, who paints a rather ominous picture in which house and apartment builders won’t be able to keep pace with demand.

Wishful thinking? Not according to the Census Bureau. The increased demand for new housing will come partly from new household formation, which (pre-recession) typically runs around 1.3 million new households each year. To keep pace, builders need to build 1.5 million new homes since more homes than households are needed to replace those destroyed by fires, floods, teardowns and neglect.  Not surprisingly, builders have not been keeping pace recently. This year builders will finish less than 400,000 new homes, the lowest number in the 47 years of record keeping.  

The worst recession since the depression has temporarily suppressed demand and household formation. In 2007, 600,000 households were formed, in 2008, 500,000, last year only 400,000 new households were formed. Kids are staying longer at home and some are returning to mom and dad’s to weather the economic storm. While new household demand has been stifled, the pent up demand continues to grow and will present huge opportunities when the economy recovers.    

New and surviving builders will also face an increasing regulatory environment which will increase the time to bring a new development on line and more costly to build. An example is the new California state law taking effect January 2011 requiring fire suppressant sprinklers systems installed in each new home. That can add as much as $10,000 to the cost of a new home. Being “green” also has a cost.

The Census vacancy numbers are somewhat misleading. The largest percentage of currently vacant homes and apartments is concentrated where nobody wants to live. Detroit and Chicago are not preferred relocation destinations. There is a reason the inventory is vacant. Some are second or vacation homes.

It may take a couple of years to get through our current inventory. While that’s happening, the population will continue to grow, new household formation will continue to be postponed and fewer new homes will be built. When the economy recovers, as it invariably will, there will be pent up demand for new homes but few available.