5 Things That Could Kill the Housing Recovery

Last Updated Jul 8, 2009 1:23 PM EDT

Everyone from Alan Greenspan all the way down the economic food chain agrees the housing market is the key to a U.S. recovery. What no one can agree on, however, is whether the housing market is starting to bounce back or is actually facing another sharp downturn.

Some Wall Street pros have looked at recent numbers and divined that housing is just about at the bottom. In May, for example, home resales increased by 2.4 percent, to a 4.77 million annual rate from 4.66 million in April, according to the National Association of Realtors. The group also said the median sale price of an existing single-family house dropped more than 16 percent in the last year, and the price tag on newly built homes fell almost 3.5 percent, too. To the optimists, this is ideal because prices are low enough to bring out the bargain hunters.

Well, the optimists have some problems. While a recovery in the housing market may be the key to righting the nation’s economy, the housing market itself also depends on a handful of other factors — among them, interest rates, the health of banks, unemployment, and political maneuvering — that are mired in uncertainty.

So go ahead and be hopeful. But keep an eye out for these five factors:

1. A Surge in Unemployment

With unemployment at 9.5 percent, there’s a tangible fear in the workforce. That anxiety could easily undermine any housing recovery, says Joseph Brusuelas of Moody’s Economy.com, as people around the country put their houses up for sale because they’re scared of getting laid off. “They are trying to get out in front of it.”

That hurts the market in two ways. First, if people are selling because they are afraid of losing their jobs, it adds more supply to a market where it will already take 9.6 months to sell all the nation’s unsold homes. That does little good for prices. And second, Brusuelas is worried about a surge of layoffs that pushes unemployment above 10 percent.“That could give us another wave of foreclosures,” he says, as laid-off workers fall behind on their mortgage payments.

2. Increase in Interest Rates

Fed chief Ben Bernanke is one of several central bankers around the world juggling ways to pump new cash into the economy while avoiding inflation. It’s important that nothing spook the market into thinking rates will rise, since low rates are key to getting people to take out new mortgages.

Already rates have popped enough to weigh on the housing market. Last week, mortgage applications in the U.S. fell 19 percent, the most since February, reflecting a slowdown in refinancing, according to the Mortgage Bankers Association.

The obvious key to a housing rebound is what Mark Grinis, a real estate partner at Ernst & Young LLP, calls affordability, or low enough interest rates to attract buyers. “At these historic low rates, we are getting toward a bottom,” Grinis says. “But we’re very vulnerable to the interest-rate environment.”

3. Wild Inflation

While there’s a lot of talk about hyperinflation just over the horizon, the market doesn’t seem to be concerned about it, at least for the immediate future. The overall economy hasn’t picked up enough steam for prices to rise in a significant way.

When any recovery does start to pick up steam, though, unemployment will likely fall, and commodities prices and global market action will rise. Historically, that means higher prices, which in turn might prod the Fed to pull back the amount of money it’s pumping into the market to keep interest rates low.

“I’m certain the Fed’s strategy is to get past this crunch and get a little more confidence,” says Grinis. “But the housing market gets repriced every day.” When rates go up a half-point, it takes thousands of potential buyers out of the market.

4. More Banking Blues

All the nation’s major banks were big players in the mortgage market, and they all took beatings when the economy melted down. They’ve since started to rebuild their balance sheets, begun lending to each other again, and raised fresh capital. “All that is good and necessary,” Brusuelas says, but there are still bad loans out there that are going to get in the way of stabilizing home prices.

But get away from the complicated balance-sheet mumbo jumbo and there’s a bigger problem: trust. Just a few weeks ago, Citibank suspended until July 6 buying mortgages from smaller banks — something that keeps the market humming — because it said it could no longer trust the appraisals on the properties being sold or the income backgrounds of the buyers. (Of course, Citi should have been as concerned about these things back in 2005 when the housing bubble was inflated to ridiculous levels, but that’s another story).

And there have been similar trust issues around a key government program meant to release some toxic fumes from the banks’ balance sheets. The Public-Private Investment Program (PPIP) hasn’t played a big role in the recovery because big banks don’t want to sell assets at bargain-basement prices, and investors who might have bought these assets worry about political backlash if they make a huge profit.

All this keeps piles of bad debts with the banks and limits how much capital they can lend out in the meantime.

5. Government Gets in the Way

As President Obama tackles an ambitious reform of the nation’s health care system, this could stretch Capitol Hill’s attention span and divert resources away from the economic crisis. When you’re having a heart attack, after all, you want your doctor’s full attention.

There’s also the question of the federal program of mortgage modifications for homeowners in danger of being foreclosed. This week, the government reported that loan modifications in the first quarter rose 55 percent compared with the fourth quarter, but seriously delinquent mortgages jumped 9 percent and foreclosures in process popped 22 percent. The Obama administration recently moved to make the program available to more people, but it simply may not be able to catch up to the magnitude of the crisis.

It would be great news for the American economy if the housing market has started to recover, but after the bubble years, the pain isn’t likely to disappear quickly. “The bottom line is that you’ve had such a significant run-up, there’s still a kind of gravity pulling at the housing market,” says Grinis. Until that market touches bottom, the rest of the economy isn’t going anywhere, either.


More on MoneyWatch: