Despite a brief respite in rising mortgage interest rates, existing home sales have dropped further faster than many financial analysts predicted, except one. National Association of Realtors (NAR) Chief Economist David Lereah warned the Federal Reserve back in May 2006 that too much short-term rate tightening could be bad for the housing market.

Back then he worried, "The Fed took the Fed funds rate to 5.25 percent. I believe they will take it to 5.5 percent and stop. If they stop -- we will be okay. If they continue towards 6 percent -- mortgage rates will approach 7.5 percent, which is the tipping point for our interest sensitive markets."

In August, the Fed decided to pause in raising short-term interest rates, the rates at which banks borrow money to loan out, but that wasn't in time to alter the momentum of slowing home prices and sales. Even so, many financial analysts believe the Fed will raise short-term interest rates one more time before the end of the year.

According to the NAR, existing-home sales were down in July, while home prices in many areas are slightly below year-ago levels, but the total drop for the year-to-date is over 11 percent. Total existing home sales -- including single-family, townhomes, condominiums and co-ops -- dropped 4.1 percent to a seasonally adjusted annual rate of 6.33 million units in July from a downwardly revised pace of 6.60 million June, and were 11.2 percent below the 7.13 million-unit level in July 2005.

The national median existing-home price for all housing types was $230,000 in July, up only 0.9 percent from July 2005 when the median was $228,000, and after several years of double-digit price increases which pressured affordability.

Alarmingly, total housing inventory levels rose 3.2 percent at the end of July to 3.86 million existing homes available for sale, which represents a 7.3-month supply at the current sales pace. That's the highest inventory of unsold homes in 13 years.

Interestingly, many date the record housing boom of the last decade to about 13 years ago when the nation began to pull itself out of the early 1990s recession. It took the Tax Relief of 1997 to provide favorable incentives to homebuyers in the form of capital gains relief if they occupied their homesteads two out of five years for a tax free gain up to $250,000 for singles and $500,000 for married couples. This spawned an era of speculation which intrigued many investors from stocks to housing. Many believe the current collapse of home sales isn't a collapse at all, but the result of speculators leaving the market, seeking gains elsewhere. This leaves the competitive field open to homeowners who want to occupy the homes they buy, making them more choosy about their long-term investment.

Ever the optimist, Lereah said higher interest rates may have dampened sales but that softer prices are good news for the housing market because buyer interest is being rekindled. "Many potential home buyers have been on the sidelines, some 'kicking the tires,' but mostly waiting for sellers to compromise on prices and terms," he said. "Now sellers in many areas of the country are pricing to reflect current market realities. As a result, there could be some lift to home sales, but it'll likely take some months for price appreciation to rise."

What could reignite the market is for mortgage interest rates to continue falling, as they have over the past several weeks since the Fed decided to pause. According to Freddie Mac, the national average commitment rate for a 30-year, conventional, fixed-rate mortgage was 6.76 percent in July, up from 6.68 percent in June; the rate was 5.70 percent in July 2005. Last week, the 30-year rate declined to 6.52 percent.

"An unexpected quarter-point drop in mortgage interest rates over the last month also could help to stimulate the housing market," Lereah said.

But the industry has to face certain market realities for at least the short-term. Lereah tells Realty Times that the larger than expected drop in home sales suggest three things:

1. the expanding regions of the nation are beginning to slow due to poor economic conditions-- diminishing the positive offset to the cooling boom markets. Places like Michigan, PN, utah, Ohio are now experiencing job losses.
2. rising rates -- in June-- inhibiting homebuying in July.
3. sellers have been slower to accept the new realities of a buyers market, sending sales down further.

"I continue to believe that there are a meaningful number of households on the sidelines waiting to purchase property as soon as sellers adjust their prices down," says Lereah. "The likely scenario at this juncture is this: home prices in most of the cooling metros will turn negative during the remaining months of this year, motivating households who have jobs because of relatively healthy local economies to purchase property. In the aggregate, I expect prices to turn negative in every region in the nation for the next several months. But that will bring demand back. I believe that July's EHS will be the trough at 6.3 million.

Further, he explains, "Confidence has plunged in the real estate industry and thus, I do not expect sales to come back anytime soon. We reached the sales floor in July and will flatten for the remainder of the year. 07 will be a flat year. The positive demographic influences will influence the real estate market in a positive way during the second half of 07 and all of 08 and beyond."

For that reason, Lereah remains bullish on real estate due to favorable demographic influences. "And yes, the Fed has listened to us," he says. "I am feeding them data on our fragile markets. They have stopped raising rates. I am satisfied with current Fed policy."