Cracks showing in keeping housing woes contained

NEW YORK (Reuters) - What happens in housing, stays in housing, right?

With apologies to Las Vegas, that has been the mantra repeated time and again by economists from Wall Street to Washington.

The meltdown in the U.S. housing and mortgage markets, stemming from rampant oversupply of new homes and brazen over-lending to credit-stretched borrowers, will remain contained and leave the broader economy generally on an even keel. Federal Reserve chief Ben Bernanke said as much just last week.

"The evidence so far is that there has been no spillover that we can see," Bernanke said last Wednesday in comments to U.S. lawmakers.

Problem is, that word apparently never got to corporate headquarters in places like Peoria and Wilmington, Chicago and Hartford.

Now, what started like a distant rumble some weeks ago with profit warnings from long-suffering home builders and retailers as disparate as Sears Holdings (SHLD.O) and Home Depot (HD.N) is suddenly a lot louder and the cadence has increased.

In the past week alone, the housing slump has emerged as a problem for a widening range of companies. Heavy machinery maker Caterpillar Inc. (CAT.N), chemicals company DuPont (DD.N) and conglomerate United Technologies Corp. (UTX.N) all said important segments of their businesses have felt the sting of the housing downturn.

Banks are doubling, sometimes tripling their reserves for loan losses. Some like mortgage lender Countrywide Financial Corp. CFC.N are signaling that credit problems are not limited to their shakiest borrowers.

Following an unexpectedly weak quarterly report card on Tuesday, Countrywide shares fell 10.45 percent, their biggest one-day drop in nearly three years.

Last week, the chief executive of KB Home (KBH.N) , the No. 5 U.S. home builder, said the housing market would remain depressed until at least 2009, longer than any previous estimate.

On Tuesday the head of USG Corp. (USG.N), the biggest wall board maker and a key supplier to every U.S. home builder, said the housing market is entering the second year of "what is likely to be a multiyear downturn."

"We're getting individual, name-specific issues popping up, and I think the market is now a little bit concerned that it is not just isolated to subprime," said George Goncalves, chief Treasuries, agencies and TIPS strategist at Morgan Stanley in New York.

Indeed, that worry is spreading among investors.

Credit markets outside the safe haven of government bonds are in broad retreat, thanks in no small part to the virtual evisceration of two hedge funds run by Bear Stears Cos. BSC.N that had made bad bets on subprime mortgage bonds.

With investors increasingly shy of taking on risk and lenders demanding better terms from prospective borrowers, new issuance of debt to finance everything from corporate stock buybacks to leveraged takeovers has virtually dried up since the start of the month.

"That growing lack of confidence -- more so than the defaults of two Bear Stearns hedge funds and the threat of more to come -- has frozen future lending and backed up the market for high yield new issues such that it resembles a constipated owl: Absolutely nothing is moving," Bill Gross, manager of the world's largest bond fund at Pacific Investment Management Co., said Tuesday.

Volatility in U.S. stock markets is also back after a long absence.

The Dow Jones industrial average .DJI fell 226 points Tuesday, its biggest point drop since March, while the benchmark S&P 500 .SPX index has had more 1 percent moves in the past six weeks than in the previous six months. Seven of those 11 sessions have been to the downside.

Meanwhile, investors are shying further away from the U.S. dollar. The dollar index .DXY, one of the broadest measures of the greenback's health, slumped to a 15-year low Tuesday, largely on concern about potential contagion from housing.

Amid such widespread anxiety, most Wall Street economists remain sanguine, sticking to forecasts that real U.S. gross domestic product growth has rebounded sharply after skidding to a near standstill in the first three months of this year.

Eyeing brisk export activity and rising inventories thanks to trade with faster-growing economies abroad, economists estimate the U.S. economy grew at a 3.2 percent annual rate in the second quarter, according to the median forecast in a Reuters poll. That growth will continue at a 2.5 percent pace or better in the third and fourth quarters.

But confidence in that outlook is showing signs of weakening.

Analysts at Deutsche Bank's wealth management unit, for one, see any rebound as temporary.

The second quarter's snapback in GDP "is not sustainable," Benjamin Pace, chief investment officer at the bank's Private Wealth Management unit, said at a press briefing on Tuesday. "Housing is still the biggest risk out there."