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SHRUGGING OFF THE HOUSING SLUMP

DEVELOPERS AND RETAILERS WORRY LITTLE ABOUT THE U.S. RESIDENTIAL SLOWDOWN

By Joel Groover

A sample of business headlines from the past few months reads like a recipe for macroeconomic vertigo. There is the good (“Wall Street Rides to New Records on Fat Profits,” “U.S. Job Picture Remains Healthy”), the bad (“Inflation Up While Economy Slows,” “Gas Prices Leave Wallets on ‘E’ ”) and the downright ugly (“Sales of Existing Homes Plunge Steeply,” “Rising Foreclosures Have Widespread Fallout”). Economists and retail analysts charged with making sense of this swirling soup of data know they must not rely too heavily on any single benchmark. But they closely watch the housing market because of its strong link to consumer spending. And on the housing front, the headlines seem to keep getting worse. Start with the subprime mortgage sector, where default rates have skyrocketed, translating into foreclosures and lender bankruptcies. Fueled largely by the growth of the mortgage-backed-securities market, these nontraditional loans, many of which lured borrowers with low-interest “teaser” rates set to rise steeply later, have market, these nontraditional loans, many of which lured borrowers with low-interest “teaser” rates set to rise steeply later, have enabled millions of low-income borrowers with spotty credit to buy new homes or refinance existing ones.

Mortgage firms have issued some $2 trillion in subprime loans over the past nine years, according to the Center for Responsible Lending, a Durham, N.C.-based advocacy group.

The Center for Responsible Lending estimates that 15.6 percent of these loans have ended or will end in foreclosure, and that some 2.4 million borrowers could eventually lose their homes. “Lax underwriting practices, dangerous loan products and a disregard for affordability have set up vulnerable homeowners to fail,” the organization concluded in a March report titled Subprime Lending: A Net Drain on Homeownership.

RealtyTrac, an Irvine, Calif.-based online marketplace for foreclosure properties, logged roughly 430,000 notices for defaults, auction sales and bank repossessions during the first quarter, up 27 percent from the previous quarter and up 35 percent from the first quarter 2006. The collapse has sparked congressional calls for new lending regulations. Sen. Charles E. Schumer, of New York, whose office predicts that some 50,000 upstate families could lose their homes by the end of next year, is among those leading the charge.

“The bottom line here is that the subprime bust is leading us right into a foreclosure boom, and thousands of people will be left in the lurch,” the lawmaker said in a press release. “We are staring straight into the barrel of the biggest foreclosure crisis ever, and action must be taken now to avoid disaster.”

These subprime sector woes have coincided with a veritable crash in the larger U.S. housing market. Housing starts will drop 20 percent this year, says Diane C. Swonk, chief economist and senior managing director of Chicago-based Mesirow Financial. Further, she says, this year will

mark the first full-year decline in resale home prices since tracking of that market began in 1991. In April D.R. Horton, America’s largest homebuilder, reported a second-quarter sales drop of 37 percent to $2.6 billion, from $4.4 billion for last year’s comparable quarter. The Fort Worth, Texas-based firm also called its 32 percent order-cancellation rate for the quarter unusually high.

Even in such traditionally robust housing markets as Florida, homebuilders that focus on properties in the $150,000 to $220,000 range have seen sales decline by as much as 60 percent, says Lee A. Dierks, managing director of Clear Thinking Group, a Hillsborough, N.J., consultant firm.

Retail chains that sell decor, furniture, appliances and other home-related merchandise are already feeling the pinch. Lowe’s and The Home Depot have blamed the housing crunch for sluggish fourth-quarter sales. Best Buy, Macy’s Group and Sears also suffered hits to their appliance sales for the quarter. “If home sales aren’t as robust, people aren’t spending a lot of money on updating electronics in their homes, buying television sets, et cetera,” said Dierks.

Some say the effects of the subprime market’s troubles on consumer spending will be marginal. “The subprime situation is bad, but as far as the fallout, this is still a relatively small group of people,” said Swonk. “They frankly weren’t your big spenders in the economy.”

But others say the larger housing slowdown in combination with higher inflation and rising energy and health care costs could squeeze a larger proportion of consumers. Some parts of the country are in the midst of a true housing recession, says Leon Nicholas, a principal of the consumer goods and retail group at Global Insight, a Boston-based economic forecasting firm. A homeowner who suddenly discovers that her condo is worth $30,000 less than she paid for it might well feel a shriveled sense of net worth, and that could certainly translate into thriftier spending habits, he says. “Are you still going to buy bread or toilet paper? Sure,” Nicholas said. “But you may shorten your vacation, and you may not buy the fridge or the flat-screen TV. Those are the kinds of things that get impacted and that trickle into broader [economic] concerns.”

Ultimately, any impact will depend on the scale and scope of the slowdown itself, of course. Swonk says ongoing gains in employment and wages are already helping to dampen the effects of the housing crunch on consumer spending. She points to U.S. Commerce Department data showing a slight rebound in housing starts for March. “We’ll have a falloff and then a slow, gradual reacceleration,” said Swonk. “The situation will stabilize in retail.”

It is also possible, though, that the full effects of the slowdown have yet to be felt. After all, many economists credited the housing bubble with driving economic growth in recent years. “When people buy houses, it generates a tremendous amount of jobs, not only from the standpoint of building homes, but also everything related to that, from construction of roads to support new subdivisions to the expansion of commercial and retail space needed to support growing communities,” said Dierks. “And, obviously, somebody is going to have to make all of those additional goods. So housing is a big deal as far as how it impacts our overall GDP.”

To be sure, some will feel adverse affects more than others. The wealthiest consumers are the most insulated, of course, and these days the chains that cater to them have plenty of customers. Not only are the rich getting richer, but also there are more newly minted millionaires than ever, says Swonk. “You’ve got the top 1 percent of households contributing 20 percent or more of the income growth in the United States,” she said. “They spend a lot, and that’s part of the reason you’ve got such winners and losers. Coach is doing especially well in its limited-edition lines that start at $1,000 a purse.” In Florida the builders of high-end, custom homes have taken less of a hit to sales than those who focus on the entry-level market, she says.

The rest of the retail universe has more to fear, says Nicholas. “If you’re selling Jaguars, or if you are Nordstrom or Neiman Marcus, you’re probably all set,” he said. “But if you’re Sears, Kohl’s, Penney’s or Wal-Mart, you’re more worried. This is particularly true if you’re relying on more of those discretionary items in your mix to obtain margin. Wal-Mart knows that it is getting a lot of volume out of its food to draw traffic, but Wal-Mart would really like you to buy a lawn mower or some apparel or electronics or audiovisual equipment.”

In the worst-case scenario, even those deemed the most insulated could feel the effects of a protracted housing crunch. “The upper class is not going to be affected by any kind of housing slowdown or bursting of a bubble,” said Martin Goldberg, an independent money manager and stock market analyst based in Wayne, Pa. “They go to Nordstrom and will continue to do so. Within the customer base of Nordstrom, however, there are people enjoying the wealth effect from the stock market and the housing market. If they don’t feel as wealthy, they might go one level down to a JCPenney or Macy’s or even find themselves below that.”

One might assume that dollar stores, the flip side of Nordstrom or Neiman Marcus, would be insulated from the housing slowdown, because their lower-income shoppers rent rather than own. This is no longer entirely the case, says J. David Cumberland, a retail analyst at Robert W. Baird & Co. “The dollar stores over time have increased their appeal to a larger percentage of consumers,” Cumberland said. “The last statistic that I saw was that about two-thirds of households shop in a dollar store each year. And so the subprime situation, higher interest rates — all aspects of that — would impact some of their customer base.”

The good news is that U.S. consumers have continued to spend in the face of a daunting set of shocks: the Sept. 11 attacks, Hurricane Katrina, record-high gas prices and the Feb. 27 stock market decline. Indeed, just two months after that mini crash, in which the Dow suffered its biggest one-day point loss since 2001, the average soared past 13,000 for the first time in its history.

Nicholas, for one, is betting on America’s Teflon consumers to do it again. “If you look at our economic history for the past 25 years or so, you had a Fed-induced recession in the early 1980s,” he said. “You had one that was brief and shallow in the early 1990s and another one that was brief and shallow after the tech collapse. That is 25 years of largely uninterrupted growth.”