Waiting for the other shoe to drop

IN ITS early days, the Obama administration argued over whether the financial system or the real economy should be the economic priority. Critics disputed the premise. They argued that no lasting recovery would be possible until housing markets were healthier.

Yet the housing-market recovery has almost run out of steam. Sales of new and existing homes have fallen for three consecutive months. As a result inventories have grown, putting downward pressure on home values. According to some measures, prices are dropping again: the Federal Housing Finance Agency reported national declines in December and January.

Things looked rosier last autumn. An $8,000 homebuyer tax credit helped stabilise both prices and sales, while Federal Reserve purchases of mortgage-backed securities held down mortgage rates. House values climbed across the country, and existing-house sales hit levels not seen since the end of the boom in early 2007. By September building-industry confidence had more than doubled from January's all-time record low, generating optimism about new employment. Anxious to keep the recovery going, Congress extended the tax-credit programme to the end of April this year. But the magic has not survived the winter.

America's weak labour market deserves much of the blame. Job losses continue to drive loan defaults. Foreclosures declined from January to February, but remained above 300,000 for a 12th consecutive month. Bank sales of foreclosed properties are depressing prices further and dampening the industry's hopes (see chart). The latest data show declines in both builder confidence and new housing starts.

The weather hasn't helped. Fierce winter storms hit house-hunting in January and February. But with prices, sales, construction and builder confidence all losing ground and foreclosures still frequent, there is growing concern that the housing-market stabilisation of 2009 was entirely a product of market interventions, most of which are about to end.

This pessimism may be overdone. With the deadline to take advantage of the housing tax credit looming and with better weather on the way, potential buyers kept indoors by February snow may rush into the market. Construction has been so depressed for so long that a flurry of buying could quickly trim inventories, supporting prices and construction and touching off a virtuous cycle in housing markets. And America's housing correction has been more thorough than those elsewhere, leaving homes much cheaper.

But the window for a turnaround is closing fast. The Federal Reserve's $1.25 trillion programme of buying up mortgage-backed securities ends this month, and mortgage rates are expected to rise thereafter. With budget politics dominating headlines in Washington, another housing-tax-credit extension is unlikely. After April, housing markets will largely be on their own. By autumn payments will be adjusted upwards on a new bulge of mortgages, while interest rates may rise further ahead of expected tightening by the Fed.

Meanwhile Washington's foreclosures policy continues to fail to rise to the magnitude of the problem. The administration's programme to restructure distressed mortgages, intended to help up to 4m households, has produced only 170,000 permanent modifications.

A renewed decline in the housing market is not inevitable, but it is starting to look increasingly likely. And if prices start to drop once again, causing both household wealth and construction employment to fall, while boosting the rate of defaults, the broader economic recovery, which is still fragile, may very well suffer as a result of housing's woes.