Home buyers hold fate of U.S. economy

Many economists say that home prices have another 10 percent to fall to bring them into balance with rents and incomes. A fall of that magnitude would elicit a huge sigh of relief from Wall Street and Washington.

But it wouldn't take much -- a further clampdown by private lenders or a meltdown at mortgage finance companies Fannie Mae (FNM.N: Quote, Profile, Research, Stock Buzz) and Freddie Mac (FRE.N: Quote, Profile, Research, Stock Buzz) -- to push home prices down much more severely, perhaps more than 20 percent.

"That's how you could quickly get into this darker scenario," said Mark Zandi, chief economist with Moody's Economy.com.

If banks tighten lending standards further, denying loans to borrowers with good credit histories, affordability won't be enough to keep people buying homes. And a sharper housing bust would leave deep scars in consumer sentiment, which would likely lead to a deep recession.

Analysts at Credit Suisse estimate that the S&P Case-Shiller Index of house prices in 20 major cities must fall by another 14 percent for houses to become affordable again, assuming the typical mortgage rate stays around 6.32 percent. The index was down 15.8 percent from a year earlier in May.

If borrowing costs eased to 5.5 percent, the Case-Shiller index may have only another 7 percent to fall, Credit Suisse said, but if rates rise to 7.5 percent, house prices may tumble another 24 percent.

A 24 percent decline would wipe out the entire home equity for millions of homeowners, many of whom were counting on their homes to finance their retirement or pay for their children’s' college education. Without that nest egg, spending would suffer; triggering a consumer-led recession that some economists predict would be the worst since the early 1980s.

"If there's a consensus, it's probably that prices will fall another 10 percent between now and next summer, which would be 25 percent down from peak to trough," said Zandi of Moody's Economy.com.

"Another 10 percent down would put prices back consistent with rents and incomes. That's a signal that housing affordability has been restored for most potential home buyers," he said.

Wall Street has already priced in such a decline, Zandi said, so that scenario could set up a healthy stock market rally and ease the pressure on banks as well as Fannie Mae and Freddie Mac.

GLIMMERS OF HOPE

Some investors saw cause for optimism in the most recent Case-Shiller index, which showed that home prices actually rose in May in seven of the 20 cities tracked, and the overall pace of decline was more modest than in the previous month.

Prices were still down from a year ago in each of the cities tracked, but they rose slightly from April to May in places including Boston, Dallas, Denver and Portland.

However, the regions at the epicenter of the housing downturn show little sign of improvement. In Los Angeles, prices were down 1.9 percent month over month. They were also down in other well-known trouble zones including Miami, Las Vegas and Phoenix.

"In Southern California, we are still not near the bottom," said Jack Kyser, chief economist at Los Angeles Economic Development Corp in Los Angeles.

"You have cul de sacs in the Antelope Valley (north of Los Angeles) where every house is in foreclosure," he added.

It is a similar story in Florida. Real estate market analyst Jack McCabe, of McCabe Research & Consulting in Deerfield Beach, Florida, said regions such as Miami, Orlando and Tampa were looking at another 15 to 20 percent drop.

"The vulture buyers are going to be purchasing for as low as 30 cents on the dollar from the peak."

McCabe cited a 245-unit condo building in the Channelside area of downtown Tampa where units had previously been selling for $200,000 to $1 million. The unsold 171 units were to be offered for a bulk sale at auction at a price of $17 million, or about $100,000 per unit, he said.

A survey of economists by Reuters showed that they expect another national decline when the Case-Shiller index for June is released on Tuesday.

On Monday, economists expect a government report on the pace of existing home sales to show a slight increase for July after a decline in June.

Meanwhile, the Federal Reserve's latest survey of senior loan officers showed banks tightening terms on a host of loans, including mortgages to prime borrowers with good credit, an ominous sign for the housing market.

"The tightening in the supply of mortgage credit is probably the last major obstacle standing in the way of a sales stabilization," Citigroup economist Steven Wieting said.

Photo: Reuters