As usual, the market panicked on news that should have been anticipated. When the mortgage crunch squeezed hardest in July, it was bound to impact pending sales, but the overreaction may be exactly what's needed to prompt the Fed to lower short-term rates in two weeks. But that's no guarantee that lower borrowing costs will move homebuyers out of their logjam.

When homebuyers aren't taking advantage of improving conditions, there's only one reason -- affordability.

Fear has ruled the markets for months, as homebuyers refused to be caught buying in a falling market. Then the mortgage crisis came along with news that foreclosures were rising, investors were refusing to buy mortgage-backed securities, mortgage lenders were closing their doors or declaring bankruptcy at alarming rates, blue ribbon lenders announced they also had a substantial number of bad loans to contend with, and money for unconventional loans had all but dried up.

That's what's rocked the housing market in July and influenced the latest pending sales report from the National Association of Realtors. The Pending Home Sales Index looks forward, much like the home builders sales which are marked by buyers making contract commitments.

What surprised most economists was the extent of the pending sales index decline. Pending home sales, based on contracts signed in July, fell 12.2 percent to a reading of 89.9 in July from the June index of 102.4. That's 16.1 percent lower than July 2006 when it stood at 107.1. The index averaged 100 in 2001, the first year the pending index was taken and published, and the lowest reading was in September 2001, immediately following the 9/11 attacks at 89.8, so the drop last month shows significant fears, problems with financing, and other barriers for homebuyers.

Lawrence Yun, NAR senior economist, said abnormal factors are clouding the outlook. “It’s difficult to fully account for mortgage disruptions in the index, and our members are telling us some sales contracts aren’t closing because mortgage commitments have been falling through at the last moment,” he said. “These temporary problems are primarily with jumbo loans, and there are continuing issues for subprime borrowers, but there are no serious problems for the majority of buyers who qualify for conventional financing or FHA-insured loans. Some consumer concerns remain, but since mid-August the market has been stabilizing somewhat."

That's a small ray of hope for sellers. Since the subprime mortgage crisis panicked the market buyers have sidelined themselves waiting for better terms on loans and for prices to come down further.

But the NAR says that the housing market will probably hold close to present levels in the months ahead. Yun says there won't be notable changes in sales activity.

“Existing-home sales should be relatively stable over the next few months, holding in a modest range, with some pent-up demand growing from buyers who’ve been on the sidelines,” he said. “Mortgage disruptions will hold back sales over the short term, but long-term fundamentals are favorable. A modest upturn is projected for existing-home sales toward the end of the year, with broader improvement to include the new-home market by the middle of 2008.”  

Many predict that the Federal Reserve will lower short-term interest rates in the next two weeks, which is a strong signal that the government bank believes that growth is slowing and outpositioning inflation as a concern. In related news, employers added the fewest workers in more than four years in August, which indicates a weakening labor market.

Growth in the U.S. gross domestic product (GDP) is projected to be 1.9 percent this year, down from a 2.9 percent growth rate in 2006; GDP is expected to grow 2.8 percent next year. The unemployment rate is estimated to average 4.6 percent this year, unchanged from 2006. Inflation, as measured by the Consumer Price Index, is likely to be 2.7 percent this year, down from 3.2 percent in 2006. Inflation-adjusted disposable personal income should rise 3.1 percent in 2007, the same as last year.

Existing-home sales are forecast at 6.04 million in 2007 and 6.38 million in 2008, still be below the 6.48 million recorded in 2006.  New-home sales are expected to total 852,000 this year and 848,000 in 2008, down from 1.05 million in 2006.  Housing starts, including multifamily units, are likely to total 1.43 million in 2007 and 1.40 million next year, below the 1.80 million units started in 2006.

“With the population growing, the demand for homes isn’t going away - it’s just being delayed,” Yun said. “More buyers, and cutbacks in new construction, will eventually draw down the inventory levels and support future price appreciation, but general gains will be modest next year. Serious buyers today have a long-term view of housing as an investment - speculators have left the market.”

He predicts existing-home prices to soften by 1.2 percent to a median of $219,300 in 2007 before rising 2.0 percent in 2008 to $223,600. The median new-home price will probably fall 2.3 percent to $240,800 in 2007, and then rise 2.3 percent next year to $246,300.

Mortgage conditions won't be better in the near term than they are right now. The 30-year fixed-rate mortgage is forecast by NAR to average 6.7 percent in the fourth quarter and then ease to the 6.5 percent range in 2008. With inventories rising, and mortgage interest rates dropping back to near-record lows, some buyers should be freed up to make a purchase, but that may only ease market conditions in the short term.

The attention has been on risk, but affordability is really the greatest issue for buyers.