Housing slump might usher in recession

updated 9:28 a.m. ET Dec. 18, 2007

The head of one of the nation’s largest homebuilders made headlines early this year by bucking his industry peers’ projections of a housing turnaround by spring and instead predicting the market would “suck, all 12 months of the calendar year.”

Boy did he get it right. The housing market has gone from a “correction” to a “slump,” and as 2007 comes to a close, there are signs 2008 will get worse.

Experts are predicting an uglier year as inventories of unsold homes grow and a large number of adjustable-rate mortgages reset, sending more homeowners scrambling to make higher payments and pressuring the already shaky credit markets. What worries industry watchers the most, however, is the possibility that the housing troubles will plunge the economy into a recession.

“I think everyone is expecting the other shoe to fall. There’s still some blood to be let,” said Jim Gaines, a research economist at The Real Estate Center at Texas A&M University. “And historically, a downturn in the housing market has been a leading indicator of a recession.”

The housing slump stands to exact a sizable toll on the broader economy as jobs, retail spending and credit availability could likely take a hit.

During the peak of housing from January 2003 to March 2006, the housing market helped to create 1.3 million jobs. Since then, only 500,000 of those have been lost. Another 800,000 could be on the chopping block.

Unlike downturns in some sectors, a slowdown in housing can affect jobs across many industries from financial services to construction to home furnishing retailers, said John Challenger, chief executive of Challenger, Gray and Christmas Inc.

Solid job and wage growth continues to support retail spending even as slipping home prices discourage homeowners from tapping equity for big-ticket purchases. But experts worry homeowners will become tighter with their wallets and save more as they watch their total household worth — of which homes make up 39 percent — decline.

Consumer spending makes up two-thirds of the U.S. economy, and already, is showing signs of slowing down. According to the International Council of Shopping Centers, same-store sales grew by 2.2 percent from February to October, compared to 3.6 percent last year and 3.9 percent in 2005. Consumer confidence also has faltered and is near two-year lows.

“Everyone agrees that the rapid rise in home prices led to increase in spending relative to incomes,” said Thomas Lawler, a former official at mortgage lender Fannie Mae who is now a private housing and finance consultant. “The question is what will the impact be on spending if equity falls.”

Both Moody’s and Banc of America Securities forecast home prices will tumble 15 percent from peak to bottom, accounting for nonprice discounts like upgraded kitchens or new swimming pools. Some worst-case scenarios don’t have home prices picking up until as late as 2012. Prices this year have dropped between 0.4 percent to 5.7 percent nationwide, depending on the measure.

Adding more pressure to pricing is the ballooning supply of unsold homes, even as builders curb new construction. Right now, inventories are at the highest levels since the post-World War II period and surging foreclosures from resetting interest rates on certain mortgages will contribute more supply.

Defaults and foreclosures have skyrocketed this year as subprime borrowers struggled with too-high payments and resetting interest rates. Banc of America Securities estimates that $361 billion in subprime loans are scheduled to reset next year, and falling home prices and tighter lending standards will keep these borrowers from refinancing into more manageable loans.

The dismal performance of these loans has clobbered Wall Street, which has reined in the capital it invests in the credit markets. Investors buy mortgage-backed securities from lenders, who, in turn, use that money to fund new home loans. Without investor capital, mortgage originations will stay low, costing lenders millions of dollars in business.

MORE FROM STOCKS & ECONOMY

Stocks & economy Section Front

Economy finally gets news to smile about Wall Street ends week with modest gains Surprising jump in June durable goods orders Consumer confidence rebounds from 28-year low Gas prices fall to seven-week low House proposal to tap strategic oil reserves fails Existing home sales tumble 2.6 percent New York sues UBS, alleges auction-rate fraud Jobless claims surge as companies retrench Dow Chemical profit sinks 27 percent Stocks & economy Section Front   Add Stocks & economy headlines to your news reader: