The Well
Coping With a Real-Estate Bust
Thursday, Sep. 13, 2007 By JUSTIN FOX
Enlarge Photo The real estate slump has no quick fix, and could expand into a full-blown recession. Here, a For Sale sign stands in front of a home in Lee's Summit, Mo., on September 5, 2007. Charlie Riedel / AP Article ToolsPrint Email Reprints Sphere AddThis RSS 
The housing market in Detroit is a mess. Such a mess that nobody tries to deny it, not even the real estate agents. "The market is very, very bad," laments Jennifer Weight, hosting a deserted Sunday open house in the suburb of Bloomfield Hills. "It's terrible."
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Across the country, in the anti-Detroit that is San Diego, real estate is also slumping. The gloom, however, is far less pervasive. "Yes, it's a troublesome market, but it's not terrible," contends broker Leona Kline.
The reason for the difference in attitude is pretty simple. In metropolitan Detroit, the 11% drop in home prices over the past year was just one more sign of a local economy in decline thanks to the troubles of the auto industry. In San Diego, the drop of 7.3% came out of the clear blue sky. The city still has jobs to offer. Beaches too.
But it is the downturn in sunny San Diego that poses the far bigger risk to the U.S. economy. Detroit, Cleveland and some smaller Rust Belt cities are experiencing a traditional bust, in which economic woes spread to housing. In San Diego, the housing decline seems to be a self-generated phenomenon, the product of too-high prices and too-crazy lending practices. Now the "housing market is dragging down the rest of the economy," says Alan Gin, an economist at the University of San Diego. The same is true in and around Los Angeles, San Francisco, Phoenix, Las Vegas, Miami, Washington, New York City and Tampa, Fla.--all metro areas where house prices skyrocketed until 2006 and have since fallen in the face of otherwise positive economic news. Nationally, house prices dropped 3.2% in the 12 months ending in June, while the economy grew 1.9%.
For much of this year it was tempting to see this disconnect as a good thing: strength elsewhere was compensating for the slowdown in housing. But when the Labor Department reported in September that job creation had lurched into reverse after four years of gains, the tune on Wall Street and elsewhere shifted abruptly. Economists began fretting that, for the first time, a real estate bust would throw the country into recession--a sustained period when the economy shrinks instead of grows and lots of people lose their jobs.
Forecasters are, as a group, notoriously bad at predicting inflection points, so you shouldn't take this dire talk to the bank just yet. At the Economic Cycle Research Institute, an outfit with a good record of at least noticing when recessions have begun, the indicators still point toward growth--albeit less convincingly than two months ago. "Having a jobs report come in negative does not mean that a recession has started," says managing director Lakshman Achuthan. But the risk is there, and Achuthan guesses it will worsen if loan markets fail to calm down. If a month from now a borrower with good credit still can't get a jumbo mortgage at a reasonable rate, a recession will be much likelier.
HOUSING'S TRAPDOOR
THAT A REAL ESTATE BUST MIGHT LAND US IN a recession is in a way fitting because it was a real estate boom that kept the last recession, in 2001, so brief and shallow. Trying to stave off deflation in the wake of the stock-market crash, Alan Greenspan's Federal Reserve cut the short-term interest rates that determine what homeowners pay on adjustable-rate mortgages. Meanwhile, investors desperate for someplace other than the stock market to put their money piled into mortgage securities, driving down the cost of fixed-rate loans. Housing markets, already doing well amid the strong economic growth of the late 1990s, exploded.
To a remarkable extent, housing drove the entire economy. Real estate, residential construction and three other housing-related Labor Department job categories together add up to 6.6% of U.S. employment. But they accounted for 46% of the new jobs created in the U.S. between January 2001 and May 2006, when the sector peaked.
The main reason for the boom's doom was that in the nation's San Diegos, double-digit annual price increases put most homes out of the reach of middle-income buyers. The mortgage industry and its funders on Wall Street responded with laxer lending standards and creative loans (no downpayment, teaser rate, interest only, etc.) that really made sense for borrowers only if prices kept going up and they could sell at a profit or refinance. When prices stopped rising last year, the edifice began to crumble.
It's in the nature of real estate that the crumbling may continue for a while yet. "It's way too premature to be talking about light at the end of the tunnel--it's still pitch black," says Ian Shepherdson, chief U.S. economist at High Frequency Economics, a research firm. Shepherdson, not a congenitally bearish sort, was one of several prominent forecasters who began warning of housing troubles in 2005. Now he sees huge quantities of unsold inventory, which will lead to more cutbacks in construction, which will lead to more job losses and so on. "I don't want to call it an endless loop, because it will end," he says. "But not anytime soon."
IT'S NOT LOCAL ANYMORE
WHEN CONFRONTED WITH SUCH GLOOMY talk, many in the real estate business offer a classic response. "People don't buy real estate on a national basis," says Tom Kunz, CEO of real estate giant Century 21. "They buy it on a local basis." Sure enough, many parts of the country aren't in trouble. Prices are still rising in Seattle and Portland, Ore. In Atlanta, Dallas and Charlotte, N.C., prices never went up all that much, and they're not falling now. The same appears to be true in many smaller cities and towns.
But most of the country's big metro areas are caught in the downdraft. With mortgage lending now very much a national business--and a troubled one--real estate may not be as local as it used to be. It may not even be national: house prices have been rising sharply in Europe, Australia, South Africa and China. Two countries at the leading edge of this boom, the U.K. and Australia, saw housing markets sputter in 2004 and 2005 but then recover. This may indicate that a quick recovery is possible in the U.S. It could also mean that the global boom will end only in a global bust--and U.S. mortgage troubles are now ominously making themselves felt around the world
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