No end in sight for housing slump

Home prices are now at 2005 levels.

And, even with the falling prices, the number of unsold homes is the highest since 1999 – as far back as the data goes – suggesting to economists that more price- cutting is ahead.

One of the major implications of the continuing slide in housing is the drag on the total economy. With home sales now lower than many of the most pessimistic forecast, some economists worry that the economy could be closing the year in a weakened state.

In fact, Wall Street is now convinced that the Federal Reserve will reduce interest rates a second time this fall when the central bank convenes next week.

"Housing is clearly the big factor for the Fed," says Jeff Kleintop, chief investment strategist at LPL Financial Advisors in Boston. "The Fed will clearly be looking at that drag [housing] on the economy and the financial consequences of the pullback."

This week, evidence accumulated detailing the housing slump. Yesterday, for example, the Commerce Department revised lower new-home sales for August to the slowest pace in 11 years. September sales rose 4.8 percent compared with the slow August pace. But, new-home sales are still 23 percent below last September.

"Technically it looks like it improved but not when you look at the downward revisions which totaled 167,000 homes in June, July, and August," says Sam Bullard, an economist at Wachovia in Charlotte, N.C. "There is so much inventory out there on the market, builders will have to put out discounts to help move this inventory off their books."

Wednesday, the National Association of Realtors (NAR), reported in September that existing home sales fell by 8 percent from August's level and are down 19 percent from a year ago. Home prices fell 4.2 percent from a year ago, and inventories were equal to 10.5 months of sales.

"The market is glutted with houses," says Peter Morici, economics professor at the University of Maryland.

According to the NAR report, there were 4.4 million existing homes on the market. The weakness is extending into the condo and coop markets where September sales fell 4.3 percent from August levels.

With weak sales and rising inventories, the median home price fell to $211,700. This is down 4.2 percent from September 2006. Part of the reason for the falling price is turmoil in the mortgage market, where it has become more difficult to obtain a loan that is higher than $417,000, the cut-off for a loan to qualify for Fannie Mae or Freddie Mac coverage.

Even in some well-to-do communities, immune to the price drop until recently, prices are under pressure. That's the case in Madison, Conn., where the average sale price is down 11.2 percent from last year.

"There is downward pressure on prices, inventories have risen," says Brendan Grady, a regional vice president for Caldwell Banker.

However, Mr. Grady says the falling prices are attracting buyers to the upscale shore community. Sales this year are up 22 percent.

Falling home prices may have a larger impact on low-income families, says Andrew Jakabovics, an associate director at the Center for American Progress. "It's more likely that a low-income borrower has made a lower down payment, so when prices fall, they may have negative equity."

The implications for a buyer holding a house now worth less than when they bought it are significant. "No one will refinance the house if it's under water [below purchase price]," says Mr. Jakabovics.

Mr. Morici says home owners with negative equity in their homes will find it difficult to buy another house. "If you have to sell and there are not enough proceeds, you get a bill," he explains. "You can't walk away from it without the lenders coming after you."

Earlier this year, many investment professionals had hoped the real estate and mortgage markets would be able hop out of trouble by year-end. However, now there are doubts. On Wednesday, Merrill Lynch shocked the markets with a $8.4 billion write down.

"We just don't know how deep in we are," says Morici.

On Wednesday, an on-line poll of real-estate finance professionals attending the upcoming Asset Backed Security (ABS) East Conference in Orlando, Fla., found still more pessimism. Ninety-eight percent of the respondents see the problems in the subprime market now spreading to higher-rated mortgages, up from 85 percent in March. The ABS conference is for professionals involved in the securitization industry – where the bulk of the financial crunch has taken place.

However, "The only thing stressing is home prices; that's not so bad," says Mark Adelson of Adelson & Jacobs, a consultant to the securitization business. "The main-stream core of the mortgage business is Fannie Mae and Freddie Mac and that's fine. That is the part of the business that puts most Americans in their homes."