Economy will get worse before it gets better

WASHINGTON -- While it is a long way from the Dust Bowl days of the Great Depression, the housing market is experiencing something it hasn't seen since that time -- a significant drop in home prices.

Many private economists believe home prices, which soared during the housing boom, will fall by around 10 percent before housing stabilizes sometime late next year. That decline will follow a 54 percent increase in median existing home prices during the prolonged boom earlier in the decade.

Prices won't be the only thing falling.

Forecasters are also looking for sales and construction to drop further until the housing slump, which began in late 2005, starts to stabilize next year.

The problems in housing have been a serious drag on the overall economy -- slashing more than a full percentage point off growth in some quarters. And those adverse effects will get worse in coming months, many private economists believe, reflecting the fallout from the severe credit crunch that hit in August.

The betting is that the overall economy will be able to avoid a recession, but it will be a close call with the point of maximum danger still ahead.

"I think the housing market has got another year of very weak sales, falling construction and lower home prices. And all of that assumes that the economy holds together reasonably well and we don't have a recession," said Mark Zandi, chief economist at Moody's Economy.com.

The biggest worry is that mortgage financing problems will grow even more severe, with soaring defaults dumping more homes onto an already glutted market, driving prices down further.

In a new report, the Joint Economic Committee estimates there will be 1.3 million foreclosures from mid-2007 through 2009 in subprime mortgages, loans provided to borrowers with weak credit histories.

Those foreclosures will wipe out an estimated $71 billion in housing wealth directly and another $32 billion indirectly by lowering the values of neighboring homes, according to the report by the committee's Democratic staff. The report predicts that will end up costing states $917 million in lost property tax revenue through the end of 2009. The states of California, New York, New Jersey and Florida are expected to be among the biggest losers.

"We are looking at a tsunami of subprime foreclosures that has been hitting subprime borrowers hard and is on track to hit prime borrowers and the economy as well by lowering property values and reducing local tax revenues," said Sen. Charles Schumer, a New York Democrat.

Committee economists caution their forecast is heavily dependent on how much home prices decline during the slump. If the downturn turns out to be worse, it will mean even bigger price declines, more foreclosures and more dollar losses in both home values and property tax collections.

Home prices have declined close to 4 percent from their peak set in early 2006, according to the Standard & Poor's/Case-Schiller index. David Wyss, chief economist at Standard & Poor's, believes before the downturn is over, home prices will fall by 11 percent, according to this gauge.

That would far surpass a 6.5 percent drop in prices, according to the Case-Schiller measurement that occurred in the 1990-91 housing downturn, the only other time this measurement has shown falling prices.

The National Association of Realtors is predicting the median price of an existing home -- the point where half sell for more and half for less -- will fall by 1.5 percent this year, the first price decline on an annual basis on the group's records going back four decades.

Before the slump ends, Zandi said, he believes median existing home prices using the Realtors' measurement will fall 10.4 percent, making this the biggest downturn in terms of prices since the Great Depression of the 1930s, when home prices dropped by about one-third.

Economists stress that the price weakness must be viewed in the context of an unprecedented run-up in prices that occurred during a five-year boom in home sales, a period that some economists believe reflected a speculative bubble that pushed prices well past affordability levels in many parts of the country.

"We had a surge in investor demand, an explosion in the availability of credit and builders who became overly optimistic. All these things came together to whip the market into a frenzy, creating a huge bubble that is now bursting," Zandi said.

In terms of construction, Zandi said he was looking for building activity to drop by 54 percent.

David Seiders, the home builders' chief economist, said housing will gradually stabilize in the next year with sales hitting a low-point in the first quarter and then starting to move higher, a development that will help clear out record-high inventories of unsold homes. He said construction will not hit bottom until the spring and housing will remain a drag on the economy through the middle of next year, with prices likely to continue falling until the end of the year.