WASHINGTON A decline in U.S. home prices is needed to attract buyers back and end the housing slump, but with no bottom in sight, more trouble lies ahead for an economy that may already be in recession.
This is a growing concern among Wall Street analysts and policy-makers, like Federal Reserve Governor Frederic Mishkin, that potential home buyers may wait on the sidelines for an extended period.
"If house prices fall more than expected, and that condition leads to more adverse expectations for future changes in house prices, then housing demand could fall as a result," Mishkin warned a group of key economists meeting in the Washington area this week in one of the bleakest public speeches by a Fed official during this business cycle.
Typically, falling home prices help stave off a downturn by boosting demand for homes and reducing the backlog of unsold homes. Even though U.S. home prices fell last year for the first time in a generation, sales continue to slow, only adding to the glut of inventories.
At the current sales pace for previously owned homes during January, there was more than 10 months' worth of homes for sale, according to the National Association of Realtors.
That was much more than the 6.5 months' supply available during the peak of the housing boom in 2006. That also comes as sales have slipped for the past six months, according to the real estate group.
NO BOTTOM SEEN
But economists fear there is no bottom in sight and that's making everyone jittery: the buyer, the lender and the investor.
"I think it's freezing the market right now," said Mark Zandi, chief economist at Moody's Economy.com in West Chester, Pennsylvania. "Home buyers are not going to catch that falling knife and that's going to weigh very heavily on the housing market through this year and next."
Home prices have indeed fallen according to the real estate group, which reported a nearly 5 percent drop in median prices for previously owned homes, the bulk of the housing market, in January from prices a year ago.
The group projects that prices for new homes will tumble 6 percent this year and 1.2 percent for previously owned homes.
Analysts warn that until there are signs the housing market has stabilized or bottomed out, buyers and lenders are likely to be very cautious.
"We're not near there yet so people are going to continue to wait on the sidelines," said JPMorgan economist Michael Feroli.
Since September, the Fed has slashed its benchmark interest rate by 2.25 percentage points in an effort to end a growing credit crisis and boost the economy. Economists are expecting the central bank will continue on this path even though there are signs of inflationary pressures.
Even with such price pressures, analysts believe the central bank needs to continue with rate cuts, saying this is key in bringing an end to what has been seen as the worst housing downturn since Great Depression.
"The Fed should forget about everything else now and just do whatever is necessary to bring a bottom for home prices into sight," said John Lonski, chief economist at Moody's in New York.
Timing is crucial because the Fed's latest data shows that the net wealth of U.S. households in the final three months of last year fell for the first time in five years as the value of real estate holdings and stocks weakened.
In that report, the percentage of equity that Americans have in their homes sank to the lowest since 1945.
"Not only have the fundamentals for housing shifted, but the psychology has shifted. Now it's pessimism with expectations of future price declines and this is not going to resolve itself quickly," said Zandi.
(Reporting By Joanne Morrison; Editing by Neil Stempleman)