Like floodwaters escaping from a damaged levee, troubles in the housing market are spilling over into the retail real estate sector. Cash-strapped homeowners are curtailing their spending, while major retailers are pulling back on expansion plans and in some cases considering selective store closures. As many as 5,770 chain store outlets are expected to close in 2008, up from 4,603 last year, according to the International Council of Shopping Centers (ICSC).

“The economy's having a pretty terrible time because of the slowdown in housing,” says Howard Roth, the chief economist of the California Department of Finance. “We have no shortage of problems,” he adds.

Record-high foreclosure rates are worrisome, according to economists. Nationally, 28.6% of all subprime loans were in foreclosure during the last nine months of 2007, while 35.1% of adjustable-rate subprime loans were in trouble compared with 4.5% of prime mortgages and 8.6% of adjustable prime mortgages, according to the Mortgage Bankers Association.

Yet the crisis in the mortgage market is not the sole cause of problems in retail, according to Michael Niemira, ICSC chief economist. He says that both the mortgage meltdown and declining retail sales are “symptoms” of the larger phenomenon of recession.

A pullback in the use of home equity lines of credit has had a dramatic effect on consumer spending, according to a recent study by economists Stuart Gabriel, Raphael Bostic and Gary Painter. In a rising housing market, homeowners can refinance their homes and cash in on the market-driven increases in home values.

Economists call the phenomenon “housing-based wealth.” In recessionary times, however, the sudden shrinkage of housing-based wealth can make the overall economy much worse because consumers suddenly have a lot less money to spend.

Gabriel, director of the Ziman Center for Real Estate at the University of California at Los Angeles, along with co-authors Bostic and Painter, both professors at the University of Southern California, found a powerful correlation between home values and consumer spending: For every 10% drop in housing values nationwide, the authors found that the Gross Domestic Product (GDP) drops 1%. With the GDP worth about $14.1 trillion at the end of last year, a 20% drop in housing prices would equal the loss of $280 billion of consumer spending.

The loss of the spending power in home equity lines is the “through-the-looking-glass effect of housing-based wealth,” says Gabriel. It's too early to tell how far home prices will drop, however.

Although Niemira of the ICSC expects a bump for retailers this spring after taxpayers receive the special tax refund authorized by Congress, a full recovery may be a slow process. “The lingering weakness will be present for quite a while,” Niemira says, and may not turn around until the end of the year. Niemira is already worrying about the next financial crisis: a “contraction” he expects sometime in 2010.