The annual State of the Nation's Housing 2008 has just been released by the Joint Center for Housing Studies of Harvard University. Abandoning the upbeat tone of last year's report, the market analysis bluntly says that the economy can go one of two ways -- a severe recession that will take housing with it, or a mild recession which will allow housing to strongly rebound.

Affordability is key, as the bust following the boom period between 2003 and 2005 illustrates. Housing prices rose ahead of incomes, but low interest rates and low-entry mortgage loans kept buying attractive. When mortgage rates started to rise in 2006, buyers lost their appetite for allocating so much of their budgets for shelter.

More than one million more households defaulted on their mortgages in 2007 than in 2006, mostly stemming from subprime mortgages. Absentee owners accounted for almost one in five loans entering foreclosure in 2006.

How quickly the defaults occurred caught mortgage investors short and they stopped buying securities backed by subprime mortgages. Banks were overwhelmed with defaults and tightened lending standards, which is still impacting housing sales today.

High housing costs in many areas have caused behavioral changes including lower household formation during the credit crunch, which is crucial to housing sales.

The bad news is that six of the last seven housing downturns preceded a recession -- usually within two years, says the report.

However, the outlook is also positive for a recovery. While the Center finds that housing conditions like excess inventory, affordability, and credit problems suggest a protracted recovery, demand for housing is increasing.

Barring a severe recession, household formation is likely to grow, due to the rise of singles, maturing of the echo boomers, longer life expectancy of baby boomers, and immigration.

But first, the markets must work through over one million excess vacant housing units for sale. Home vacancies shot up from 2.0 percent in the last quarter of 2005 to 2.8 percent in the last quarter of 2007. Until those homes are occupied, new home production won't increase. But once that inventory overhang is gone, prices will firm, and production will increase to normal levels, igniting a new housing boom.

Published: June 24, 2008

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