RealEstateEconomyWatch.com

Don’t let recent good news about the nation’s housing sector lull you into believing that the housing market is firmly on the road to recovery-because it isn’t. There is a long and winding road ahead.

It is difficult to ignore the good news. The housing sector scored a trifecta in October-home sales were up; home inventories were down; and home values were stabilizing. Existing home sales surged10.1 percent to 6.1 million annualized units in October compared to a month earlier, while new home sales gained 6.2 percent to 433,000 in October, representing the strongest pace since the fall of last year. More encouraging was that the months’ supply for existing homes posted a cyclical low of 7 months in October, while the months’ supply for new homes registered a cyclical low of 6.7 months.

The median price for existing homes fell 7.1 percent in October compared to October 2008, the second consecutive month where the decline was in single digits. More heartening was the meager 1 percent decline in the median home price in October compared to September. The median price for new homes fell only 0.5 percent in October from a year earlier.

Pushing good news aside, the housing sector remains fragile and its fate is very much subject to the whims of the federal government. After a year of unprecedented government intervention, the housing sector is now propped up by a maze of federal housing programs, direct housing subsidies, lenient government underwriting practices (e.g., FHA), and an enormous mortgage-backed security purchase program. Combining this convoluted web of subsidies with a backlog of foreclosures due to hit the streets next year, paints a fragile and tenuous picture of the housing situation.

To illustrate the magnitude of housing’s vulnerability, consider the impact of this past year’s first-time homebuyer tax credit on home sales. Economy.com estimates that the original tax credit resulted in an additional 500,000 home sales that would otherwise not occurred in the absence of the tax credit. As of October, aggregate home sales were 6.53 million annualized units (6.1 million existing sales; 433,000 new sales). If the tax credit never existed, it is likely that October’s aggregate home sales number would be closer to 6.03 million (6.53 million minus 500,000) annualized units rather than today’s 6.53 million number.

To further illustrate the strength of government subsidies on housing activity, consider the impact of the Federal Reserve’s mortgage security purchase program. Most economists believe this program has brought mortgage rates a full percentage point below where rates would have been in the absence of the security purchase program. Under normal market conditions, a one percent drop in mortgage rates usually translates into an additional 250,000 home sales. It follows that when the Federal Reserve ends the security purchase program (due to expire early next year), mortgage rates will gradually rise by a percentage point resulting in about 250,000 less home sales.

Sometime early next year, the homebuyer tax credit and the Fed security purchase program will cease to exist and the housing industry will have to pay the piper. The homebuyer tax credit which is due to expire in April 2010 is projected to add an additional 500,000 home sales; the same estimate as the previous tax credit. Assuming everything else stays the same, the expiration of the tax credit and the Fed security purchase program would result in 750,000 less home sales on an annualized basis. That number would be difficult for the markets to digest and would likely curtail the housing recovery.

Of course, everything else does not stay the same. The government is betting that the economy is healthy and growing by early next year, generating monthly job gains rather than losses. Increased job security and rising consumer confidence are expected to partially offset the negative impact of removing the two housing subsidy programs.

Eliminating subsidy programs is no trivial task; timing is critical. The government needs to unwind the web of subsidies that it has spun to keep the housing sector afloat with caution and careful timing. A successful housing recovery depends on it.