If the economy slides into recession, will it be because of the housing downturn? Conversely, if the housing market crashes completely, will it be because of the economy? Or both? This third installment of Big Builder's series on economic scenarios for the coming months examines the relationship between housing and the overall economy. Not surprisingly, they are linked, but the conundrum is that there is no precedent for the current state of affairs. Never before has housing fallen as far and as fast as it has while the economy was growing. Still, given the magnitude of the decline in new-home sales, pricing, and starts, there is no question that things will worsen considerably if the national economy tanks. The impact on builders would vary. Among the big publics, which account for some 35 percent of the home building market, the well-managed builders could probably weather the storm, continuing to shrink balance sheets, and methodically work off inventory and landholdings. The less-well managed could face trouble; the more land they impair, the more they erode equity, the book value of the company, and thus the stock price, making them acquisition targets, at best. Up against loan covenant triggers, they could not prop up their stock prices with buyback programs. No one would lend them money. Bankruptcies could result. Among private builders, those with too much debt would go under, as they always do in recessions. Some already have. Most builders will continue or accelerate their orderly withdrawal from unappealing markets and just get smaller. And pray that the recession is short and mild.
Ever since the first economist stumbled upon the theory of supply and demand (it was actually the 19th century French economist Antoine Augustin Cournot who did so), business has been conducted largely through the attempt to achieve balance between the two. When the two are in balance, the market is said to be in equilibrium. This is not the ideal situation from the business owner's point of view, but it is at the least orderly. It is to the business owner's advantage to limit supply enough to drive demand to slightly outstrip supply. That allows for the raising of prices and profit margins. The wild card in the supply/demand equation is thus scarcity. Scarcity can be good for business, as in when there are more buyers chasing goods then there are goods. But it also can be bad for business, as in when goods are too scarce businesses cannot make enough to satisfy demand.