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by John R. Burgess

The impact of housing starts on small business

Every day there is news about the disaster following the home-building industry in America. Article titles include "Glut of Unsold Homes Rises to 18-Year High", "Home Prices Falling at the Fastest Pace in 16 years" and "Sales of Existing Homes Are Down 12.8 percent in August 2007, Versus August 2006." According to Alan Greenspan, housing prices should, could or will drop much lower and the Federal Reserve wants to reduce interest rates to resolve many of the problems reported by the media.

How does that impact American small and medium-size businesses? Of the precipitous decline in housing starts, American homebuilders are experiencing great difficulty during this time due to declining revenues across the board. This is precipitated by the fact that the psychology of the home-building industry has changed dramatically. There was a time when everyone assumed the right place to put discretionary income was into a home. The reason is that all Americans expected their homes would be worth more tomorrow than today. Some exceptions included Southern California, New York and various other hotbeds. In those particular areas, prices escalated so rapidly that they eventually had to come down and moderate to some degree, but still averaged high, single-digit increases on a yearly basis.

Many companies decided they could make additional sums of money by granting mortgages such as no-document loans and zero-based interest loans. It was a "house now and pay later" situation. That may be a bit of an exaggeration, but barely. All of these modifications were made so that companies could make more money on lending money out to sub-prime borrowers than what they could lend to those with established, good credit. Eventually, this helped to cause the current catastrophe befalling the housing starts business.

Will the Federal Reserve’s decision to reduce interest rates modify the current catastrophe in the housing industry? What exactly is the current catastrophe in the housing industry? It is the glut of unsold homes at an 18-year high coupled with prices falling at the fastest pace in 16 years. The former Federal Reserve Board Chairman Alan Greenspan said that housing prices are going to drop much lower and that he did everything in his power to control the bubble, but was incapable of controlling it. This is clearly a catastrophe.

What needs to be done? The Federal Reserve thought we needed to reduce interest rates in order to change the home buyer psychology to go back to believing that the spending money on a home would produce a return on investment. The problem is that the declining dollar, based on the value of the dollar on hard-core based assets, that once we reduced the interest rate by a half a percentage point, which caused the dollar to plunge against the Euro, interest rates rose because the value of the bonds declined. Therefore, we will have very little impact on the overall 30-year fixed interest rates, or even adjustable rate interest rates, by the imposition of this rate cut.

What should the government do? The government and the people, including all small and medium-size businesses, need to work together to change the psychology that the market is so bad that it’s never going to change. One thing that has always impressed me is that nothing ever goes straight up and nothing ever goes straight down. The psychology of the change in the marketplace in the housing industry can change overnight. To do that, though, we need to stop reading the bad news that the unsold homes have risen to an 18-year high and that the housing starts have fallen to a 16-year low. Focus on the fact there is a limited supply of land in America. There is a limited supply of places where homes can be built and population continues to grow. As long as we believe in the law of supply and demand, we have to believe in housing. In this intervening period, though, it has been incredulously difficult for the homebuilders and any small and medium-size business owner dealing with the homebuilding industry. It is difficult to understand how everything can change so quickly.

I will talk to you next quarter.

John R. Burgess is the founder and driving force behind IPA, the world’s largest management consulting and professional services firm specializing in the small and medium-size business marketplace.