Five consecutive years of a broad, global, economic surge have got macro-savants–including former chairman of the Federal Reserve, Alan Greenspan–wondering when, not if, the current run-up will die of old age.
There are those who don't believe for a nanosecond that up-cycles expire in this fashion, but a number of economic data points are beginning to betray the fits-and-starts hesitancy of an engine losing steam, willing but perhaps not able to go on intrepidly into the future. Corporate earnings notching down; capital investment, particularly among industrial companies, declining; job gains increasingly tending to occur in low-paying services areas; and consumer sentiment, heretofore a heroic factor in keeping the economy thumping along, seeming to reveal a growing lack of conviction. Laying the odds on the likelihood that the "R" word will pop into the collective conscious in the next six to 12 months has become an almost obligatory part of every CNBC interview with economists of all stripes.

"This next year ... has got to be about flawless execution, strategic allocation of our capital where it makes sense, and margin generation. I truly believe we can be a leader in those given what we have done in '06." –Cathy Smith, CFO, Centex Corp. Photo: David Lawrence Were it not for apparently boundless troves of global liquidity–trillions of investment-hungry dollars looking for places to grow at an advantaged pace in private equity and hedge funds–and a presidential election year ahead, one might think therewas nothing to keep the economy in positive territory except home builders' most earnest prayers that they can extract themselves from this funk before we hit gross domestic negative-land.

Yes, there's housing, whose year-plus-old woes have already taken a good two points or more out of the GDP. Housing, which enjoyed a protracted surge cycle of its own that got underway with a housing recovery in the mid-1990s, appeared intent on surfing demographic destiny and economic strength into the next decade without so much as a breather. All went as planned for almost 10 years. Then toward the end of the summer in 2005, everyone seemed to wake up at one time and arrive at the same conclusion: There was a far greater number of people buying new homes to turn around to sell than there were people buying homes to live in than anyone had previously counted on. This phenomenon began to make housing too expensive for the many people who bought houses to live in.

Mortgage lenders, in turn, provided an easy-money Band-Aid that would crescendo over the past three years, giving a lot of executives promotions and bonuses for keeping capacity running with demand before it unraveled. "Never mind that practically anyone with a pulse could get a loan," wrote Eric Belsky, executive director of the Joint Center for Housing Studies at Harvard University, in our pages last November. "Why worry that easy credit standards and rising interest rates could put homeowners at risk of losing their homes?"

Hard Lessons

Warning salvos that rang out in the summer of 2005–Sacramento, Calif.; Washington, D.C.; Fort Myers, Fla., to name a few markets that suddenly became a big problem early–offered clear, bellwether intelligence that should have, by all rights, guided strategic plans and operational and financial management tactics for 2006.

All the telltale signals showed that there was too much supply for too high a price for too few people. But housing's last big run-up didn't pass away with time to process, grieve, and mourn. Its demise was shocking and deeply paralyzing–seeming to catch the entire industry mid-sentence talking ever optimistically about ways to increase capacity and speed up the machine.

In all candor, "our biggest mistake was [that] we just didn't pick up the effect of the speculator" dimension of home buyer demand, admitted The Ryland Group CEO and president Chad Dreier to Wall Street professionals at a UBS Investment Research forum on home building hosted by managing director Margaret Whelan in late November 2006.

If, and what a huge "if" it is, our universe of 22 public home builders had known what lay ahead for housing around the time Hurricane Katrina hit–namely, that a $30 billion to $40 billion chunk of their delivered home sales would vanish from the market by 2007–would they have crafted dramatically different strategies and tactics? Would speculative starts have ceased altogether? Would back-of-the-envelope calculations have revealed that between zero sales to speculators and the restoration of modicum of lending standards that they would have about 300,000 excess new homes to work through (about three consecutive years worth) on top of starts, on top of the backlog absorbing cancellations, and on top of the "accidental specs" that occur when flippers flip?

Could or would anyone among home builders' top management have behaved any differently? Maybe not.

As he explained to the Wall Street investment community last November why Hovnanian Enterprises would eventually take fourth-quarter land write-downs of more than $300 million against 2006 earnings, president and CEO Ara Hovnanian said, "We found it primarily on–the majority of it, really, coincides to properties where the contract was signed and/or closed in 2005. I mean, that was the challenging year in hindsight, and I wish I went on a long vacation in 2005. But we didn't. We've been in the market. And you have to be in the market. But there are times when the market hiccups and you find yourself with some land at a cost basis that you wish wasn't there, and we just have to deal with it."

From an outsider's perspective, it looks as if what senior management at most of the companies did was to lay out a strategy for 2006 that looked a lot like that of the previous few years, less one out of 20 houses or so. Depending on how well each of them course corrected tactically, that's what set one apart from another in performance. Some builders chose a massive margin compression route to work through as much inventory as possible. Others leveraged less exposure to expensive land positions to focus on taking other operational costs out, seeking top line margin protection. Some jumped into discounting and concessions action, while others were slow to react. Hindsight is 20/20, but did anyone pay enough heed to the omens of 2005 and drastically cut output, stop taking down lots, or look to bring affordability back in line beginning last year?