There is something in the air and it does not portend favorably for the nation’s housing sector. Housing activity is sputtering even though there are government subsidy programs in place to support housing demand.

Existing home sales fell 16.7 percent to 5.45 million annualized units in January, while new home sales fell 11 percent to an annualized 309,000 units for the month. The pace of new home sales in January is at the lowest pace on record. As a result, the months’ supply rose to 9.1 for new homes and 7.2 for existing homes.

And according to two leading indicators-mortgage applications and pending home sales, housing activity will get worse before it gets better. Mortgage applications to purchase homes are now at the lowest level, as measured by the purchase index, since 1997. The pending home sales index fell 7.6 percent in January from December, and is now at the lowest level since March of last year.

Both leading indicators suggest the housing correction is far from over. Pending home sales are contracts to purchase existing homes and usually lead existing home sales which are closings by one to two months. Thus, expect a relatively weak pace of existing home sales throughout the first quarter. To make matters worse, the National Association of Realtors noted that abnormal winter weather is likely to have depressed pending home sales further in February. So the actual home sales numbers could end up being worse.

Home values are also sputtering. Home prices stabilized in early 2009; then edged higher in the second half of the year; and now show signs of weakening. The Case-Shiller Home Price Index for 20 Cities rose by only 0.3 percent in December from a month earlier and is down 3.1 percent compared to a year ago. The Federal Housing Finance Agency’s (FHFA) home price index fell 1.6 percent in December. Despite home values weakening, the level of home prices across the nation appears to be in line with rents and household income, suggesting that home values are now affordable. Indeed, the National Association of Realtors’ affordability index is at an all-time record high. So why are home values weakening again?

The answer is due primarily to excess supply of properties for sale. As long has there are imbalances in the supply of homes across much of this nation, home values are not likely to stabilize. Moreover, rising foreclosures are adding to the inventory of homes, exerting further downward pressure on home values. Economics 101 tells us that home prices will not be in balance until excess supply vanishes.

Surprisingly, the recent retreat in housing activity has occurred against a backdrop of multiple government housing subsidies, designed to spur housing demand. The Federal Reserve’s mortgage security purchase program has kept thirty-year mortgage rates hovering near historic lows. Similarly, two of the largest housing subsidies-Fannie Mae and Freddie Mac (under government conservatorship) continue to feed money into the mortgage market, exerting downward pressure on mortgage rates. And the home buyer tax credit program continues to entice households to purchase homes.

Looking forward, the economy is not helping the housing recovery. Economic growth remains relatively weak and is not strong enough to create jobs. Job losses represent the greatest obstacle to a full housing recovery. The most likely scenario has home sales retreating in the first quarter; but due primarily to the extended and expanded homebuyer tax credit combined with an expected rebound in the job market, home sales are expected to modestly climb during the remaining 3 quarters of the year. As a result, excess inventories should shrink a bit throughout the second half of the year. Softening inventories are expected to ease downward pressure on home values. I expect home prices to stabilize sometime at the end of 2010 or the beginning of 2011.

And if this scenario does not play out, I will have to find another scenario.