Will a housing double dip deflate the wheezing jobs recovery?

It seems impolite to ask, what with employment growth sucking wind already. Companies added just around 100,000 jobs a month over the past year, a rate Fed chief Ben Bernanke dismissed Friday as "insufficient to materially reduce the unemployment rate."

But it gets worse. Economists at Bank of America Merrill Lynch say one key to a jobs recovery is an improvement in housing -- because so much job creation is driven by new businesses that have in recent years been financed in part by home equity borrowing.

This sort of job creation has been missing the last couple years, thanks to the housing crash. If U.S. house prices embark as expected on a new decline, the long-awaited hiring renaissance could be put on hold yet again.

"There has been an adverse feedback loop where low home prices lead to tight credit, hurting jobs and prolonging the housing recession," writes economist Michelle Meyer.

Much of the concern about another housing downturn revolves around the banks. A sharp house-price decline could lead to more foreclosures, hammering profits and reducing lending, such as it is.

But Meyer points to another effect that could be equally powerful for the jobs market. She notes that falling house prices hit home equity, preventing small business owners from tapping a key source of financing.

A recent study by the Cleveland Fed found that at least a quarter of small business owners in 2007 used home equity to finance their business. With as many as 1 in 4 homeowners under water on their mortgages, many would-be employers are unable to borrow as they were during the boom.

"Returning small business owners to pre-recession levels of credit access will require an increase in home prices or a weaning of small business owners from the use of home equity as a source of financing," wrote Fed economist Mark E. Schweitzer and Case Western enterpreneurial studies professor Scott A. Shane.

That's important because a disproportionate amount of job creation comes from new business start-ups, which of course typically at least start small. Start-ups account for just 3% of overall employment but 20% of new jobs in any given year, according to Meyer.

When that engine sputters – as it has in recent years, with tight credit and consumer belt-tightening – it robs the economy of one of its driving forces. This has been the condition ever since the recession started, according to BofA.

Business formation peaked in the third quarter of 2007 and fell sharply for the next six quarters, bottoming in early 2009. However, there was little recovery since then with the pace of new business formation holding roughly steady at 1Q09 levels. Job creation from business formation continued to decline and as of early 2010 was still insufficient to offset the number of jobs lost from business closings.

This isn't the only problem in the jobs market, of course. There are lots of moving parts beyond housing, such as plunging labor force participation (see chart, right) as discouraged workers give up on trying to find work. And there is considerable imprecision in comparing and contrasting the many jobs reports, all of which have their pros and cons and some of which come out only after considerable delay.

"The surveys can't catch everything, but it's obviously correct that some older folks who lose their jobs are not going back into the work force," said Jeff Miller, a Chicago-area investment adviser who follows the economy at his A Dash of Insight blog. "And there are people who can't move to get a new job because they can't sell their house."

And it's worth noting that Meyer isn't calling for the jobs picture to grow even dimmer. She predicts the U.S. economy will add 175,000 jobs a month over the course of 2011,  which will bring the unemployment rate down a shade, to 8.7% from the recent 9.4%.

Yet perversely, bad news for housing and jobs now conspire to keep the wind behind the stock market, which is addicted to free money from the Fed.

Indeed, some of the dynamics undermining U.S. workers – cheap financing for big, global companies that do much of their hiring overseas; rising productivity as employers stretch resources and trim fat; and a surplus of both workers and production capacity – spell good news, at least at the moment, for investors.

"We have bad news for an awful lot of people, but it's a Goldilocks economy for stocks," said Keith Springer, a financial adviser in Sacramento. "The Fed is trying to create a bubble of artificial demand to create the wealth effect. It doesn't do much for jobs, but for now it's pretty good at driving stock prices."