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Laying the Foundation for Recovery


A rebound in the housing sector is the key to an economic turnaround. That may be a ways off, but Washington policymakers are helping to stabilize the market

If you're looking beyond the current gloomy economic conditions toward brighter times, you should know that any recovery must begin with housing. It's the origin of the turmoil in the credit markets, and tighter credit conditions are the biggest threat to overall growth. The bad news is a housing turnaround is still a ways off. The good news is that policy moves by the Federal Reserve, Congress, and other Washington agencies are laying a foundation that will stabilize housing and support an upturn.

The road to a housing recovery is easy to map out: Housing starts have to fall low enough relative to sales that inventories are reduced to the point where people begin to expect firmer prices, a key to stemming mortgage defaults and shoring up the market for mortgage-backed securities. Getting there is the hard part. In February, new-home sales fell to a 13-year low, and starts of single-family homes dropped to a 17-year low. Prices of existing homes in January were down 10.7% from a year ago, based on the Standard & Poor's/Case-Shiller index for 20 cities, and the decline is accelerating.

Spots of Promise in Housing

Firmer demand is crucial to the stabilization process, and the latest news is not all bad. Sales of single-family existing homes rose in both January and February and now stand above their fourth-quarter average. Also, an index of homebuilders' assessments of market conditions, which remains near a record low, has stopped falling, and builders note a stirring in buyer traffic through model homes.

The mix of lower prices and mortgage rates is helping. Consumers say home-buying conditions have been improving in recent months, based on a Reuters/University of Michigan survey. The National Association of Realtors' Housing Affordability Index, which is based on the ability of a family earning the median income to qualify for a 20%-down, 30-year mortgage on a median-priced home, hit a three-year high in January.

There has even been some movement in the glut of home inventories. The stock of existing homes represented a 9.2-month supply at the recent pace of sales. That's down from the high of 10.2 months last October, but the normal level before the bust was around five months.

Washington's recent efforts will help, too, and even larger mortgage relief plans are winding their way through Congress. Against current market conditions, Fed rate cuts alone won't necessarily reduce mortgage rates. Despite the Fed's big January cuts, mortgage rates rose through mid-March, as the spread between mortgage rates and Treasury yields ballooned, indicating the secondary mortgage market was drying up.

Improving Liquidity

Several recent moves will help to restore liquidity, especially changes for Fannie Mae (FNM) and Freddie Mac (FRE), government-sponsored enterprises (GSEs) that buy loans and repackage them for sale in the secondary market. Regulators have temporarily raised the growth caps on the GSEs' loan portfolios, greatly increased the size of mortgages that conform to GSE guidelines, and on Mar. 19 freed up at least $200 billion in additional capital the GSEs can use to buy mortgages and mortgage-backed securities.

A move on Mar. 24 by the regulator for Federal Home Loan Banks could boost their purchases of mortgage securities by more than $100 billion. Plus, the Fed's new lending facility for key securities firms will reduce the urgency for dealers to try to sell mortgage-backed securities at fire-sale prices. Greater demand for mortgage securities in the secondary market, along with reduced supply, will result in a more liquid mortgage market that will encourage primary lending to home buyers and lower mortgage rates.

Housing will need all the help it can get to face down the headwinds. The stiffest may be a recession that threatens to cut further into home demand, as job prospects weaken and consumer confidence plunges. Still, with Washington pouring in unprecedented support, prospects for at least the beginning of a recovery later this year remain favorable.

Cooper is BusinessWeek's senior editor and senior economist and writes the influential Business Outlook column.

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