Ailing U.S. consumers might foreshadow recession

By Jonathan Stempel

NEW YORK, Nov 8 (Reuters) - As the U.S. credit crunch wreaks havoc throughout the financial industry, some worry it might herald a coming recession.

Executives and analysts at the Reuters Finance Summit this week expressed concern that consumers already straining under high-cost home loans may soon start falling behind on credit card and other payments. They said this could cause damage to the broader economy, and perhaps cut deeply into bank profits.

"My concern is more the consumer at this point, given what's happening in the housing market, and the knock-on effect that might have on consumer spending," said Robert Kelly, chief executive of Bank of New York Mellon Corp (BK.N).

"I won't say the odds (of recession) are higher than 50-50, but I think it's close; clearly, more likely now than they were two months ago."

Falling home prices, rising borrowing costs on adjustable-rate mortgages, and tighter credit-market conditions are expected to cause 2 million foreclosures by the end of 2008, Chief Economist Mark Zandi of Moody's Economy.com has estimated.

The slump is also thrashing home builders and developers, banks have said. Hovnanian Enterprises Inc (HOV.N) and Toll Brothers Inc (TOL.N), two large home builders that cater to wealthier customers, this week reported falling construction volumes and higher cancellation rates.

HOME NO LONGER A CASTLE

Yet while major lenders such as Citigroup Inc (C.N) and Capital One Financial Corp (COF.N) have boosted reserves for or estimates of consumer credit losses, there isn't a consensus on how widely the crunch will extend -- how deeply, for example, it might affect credit card issuers.

Consumers are "behaving different than we're used to," said Tanya Azarchs, senior banking analyst at Standard & Poor's.

"They may not think their home is their castle to be protected at all costs," she said. "When they have no equity in their house, they may turn in the keys to a greater extent than they would before, and keep their credit card afloat. Usually people default on their unsecured debt before they default on their house, and it's not happening."

Rising delinquencies and defaults on home loans have already triggered big mortgage losses at companies such as Countrywide Financial Corp CFC.N, the largest mortgage lender, and Washington Mutual Inc WM.N, the largest savings and loan.

It has also caused tens of billions of dollars of losses in subprime and other mortgage securities at Citigroup, Merrill Lynch & Co MER.N, Morgan Stanley (MS.N), American International Group Inc (AIG.N) and other companies. More are widely expected.

SHIFTING WINDS

"We've come off probably the best five-year period in terms of consumer credit in the industry," said Joseph Campanelli, CEO of Sovereign Bancorp Inc SOV.N, the second-largest thrift. "The winds have shifted. The question is, do we go into a mild recession, or do we grow at 1 or 2 percent a year?"

Campanelli estimated a 30 percent chance of recession.