Cover Story May 28, 2008, 4:52PM EST

First Housing, Now Oil

The double whammy of rising oil prices and plunging home prices could turn a mild recession into something more threatening

by Peter Coy

Sky-high gas prices are just beginning to curb U.S. consumption Justin Sullivan/Getty Images

null

In Charlotte, N.C., gasoline at nearly $4 a gallon is cracking "the survivors," as credit counselor Bruce G. Hamlett calls them. They're the people who played by the rules and kept up their mortgage and utility payments even as neighbors gave up and moved away, leaving empty homes. Now, crazy prices at the pump are pushing even these survivors over the edge. "They're asking, 'Do I put gas in my car or do I pay this utility bill or do I pay the mortgage?'" says Hamlett, director of economic independence for Charlotte's United Family Services. "It's getting to the point where it's an impossible choice."

For the U.S. economy, the twin shocks from oil and housing have become mutually reinforcing, potentially turning what may be a mild recession into something more threatening. Even those economists who think the U.S. might dodge a recession are concerned. Home prices are seemingly in free fall in much of the country. The Standard & Poor's/Case-Shiller National Home Price Index fell a record 14.1% in the first quarter from a year earlier, S&P reported on May 27. And now oil. After surging nearly 30% in two months, to $131 a barrel on the New York Mercantile Exchange on May 28, oil is twice as expensive as a year ago. "Up until now, housing has been the bigger story. Now I would put energy at potentially the same size," says James D. Hamilton, an economist at the University of California at San Diego.

It's enough to make a lot of people downright depressed. According to the Conference Board Consumer Confidence Survey released on May 27, Americans' expectations for the economy over the next six months hit their lowest point since the dark days of December, 1973—during a long recession triggered by an Arab oil embargo. Businesses aren't feeling exuberant, either. New orders for durable goods fell half a percent in April, the third decline in four months. Michael S. Hanson, senior U.S. economist at Lehman Brothers (LEH), expects the U.S. economy to grow at a slow 1.2% in 2008 and an even weaker 0.6% in 2009 as the headwinds from oil, housing, and the credit crunch continue.

A Painful Period of Adjustment

Given enough time, history shows, Americans can adjust to almost anything, from the demise of the family farm to the decline in factory jobs. In the long run, they can adapt to high oil prices by buying fuel-efficient vehicles or finding jobs closer to home. Likewise, with enough time, if they can't afford their homes, they can eventually cut a deal with their lenders or quietly move to a cheaper house or rental.

Trouble is, this ain't the long run. The one-two punch of rising energy prices and falling home prices has landed so quickly that many American families and businesses are breaking rather than bending. The evidence is the rapid rise in foreclosures, bankruptcies, and job losses. Actually, Charlotte is in better shape than most places. Home prices in the metro area were up slightly in March from a year earlier. Things are far worse in cities like Miami (down 25% over the past year), Detroit (down 18%), Phoenix (down 23%), and Las Vegas (down 26%).

The oil and housing woes are felt most heavily by the middle and lower-middle classes. The very poor are less affected because they don't own cars or houses, while the well-off have a cushion of savings and spare income to help them ride out the storm. Those in between have no such buffer.

On the business side, hardest hit are the sectors of the economy that are exposed to both rising oil prices and falling home prices. Detroit, for one. Automakers are being crushed because of falling sales of the gas-guzzling SUVs and pickups that, until now, made up the lion's share of their profits. At the same time, the housing bust has tightened credit conditions, making auto loans harder to get and cutting off the flow of home-equity loans, which many people use to buy vehicles. U.S. motor vehicle sales fell to an annual rate of 14.4 million in April from a total of 16.6 million units last year. Automakers can't do much about the credit squeeze, so they're focused on making more fuel-conserving vehicles. "This is a structural change, not a cyclical one," Ford Motor (F) CEO Alan R. Mulally acknowledged to reporters recently.

Reader Discussion

 

BW Mall - Sponsored Links

Buy a link now!