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Analysis: What a Housing Bust Means for Business

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August 31, 2005--In a speech Sunday, Federal Reserve Chairman Alan Greenspan said that the booming housing market was headed for a near-term slowdown. The assessment of what he has called housing "froth" was his most critical to date and echoed the concerns of some economists and small business experts, who argue that a possible slowdown would hurt the bottom lines of small businesses, including those with no connection to the real estate industry.

Greenspan's comments were delivered at a symposium sponsored by the central bank in Jackson Hole, Wyom. "The housing boom will inevitably simmer down," he said. "As part of that process, house turnover will decline from currently historic levels, while home price increases will slow and prices could even decrease. As a consequence, home equity extraction will ease and with it some of the strength in personal consumption expenditures."

It is this last point -- the potential decrease in personal consumption -- that should be cause for concern among small business owners, said Bill Rossi, a professor of entrepreneurship at the University of Florida, citing soaring home prices in especially hot markets like South Florida and the Bay Area. "Right now, people feel more wealthy, so they are freer spenders" he said, adding that small businesses across industries have benefited significantly as a result. "When housing prices decline, that is going to put a blanket over all of this."

Companies in industries directly related to the boom -- such as real estate, construction, and finance -- could suffer a prolonged sales slump once prices level off, Rossi said. "The smaller guys in the construction support business" will struggle if they are expanding too quickly and cannot absorb a drop in demand, he said. "The ones who are less cunning will go out of business."

For years, economists have been warning of a possible housing bubble, but the Greenspan comments -- along with a report by the National Association of Realtors last week showing that home sales declined in July by 2.3% -- suggest that some kind of slowdown may be imminent. "Frankly, [housing prices] are growing at a rate that is not sustainable," said Mike Fratantoni, an economist for the Mortgage Bankers Association, "but there should not be a dramatic impact." He attributed price increases, 12.5% over the past year according to government data, to demographic changes, job growth, and low interest rates for long-term mortgages.

While economists agree that a situation akin to the technology bust of 2001 is unlikely, some believe that the risks presented by current housing market are being understated. Mark Zupan, an economist at the University of Rochester said that interest rate increases could be more severe because of high levels of government spending. "Sooner or later, we're going to have to pay the bill through borrowing," said Zupan, adding that this will put further pressure on interest rates. As a result, smaller, less sophisticated companies that have benefited from the real estate boom may have a hard time staying afloat. "It's like a game of musical chairs: everyone keeps circling and the person who gets the chair last survives."

Last updated: Aug 31, 2005




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