The willingness and ability of Americans to come back into the housing market over the next few months will determine whether the US economy experiences a mild downturn or the deepest recession in 30 years.
Many economists say that home prices have another 10 percent to fall to bring them into balance with rents and incomes. A fall of that magnitude would elicit a huge sigh of relief from Wall Street and Washington.
But it wouldn't take much - a further clampdown by private lenders or a meltdown at mortgage finance companies Fannie Mae and Freddie Mac - to push home prices down much more severely, perhaps more than 20 percent.
"That's how you could quickly get into this darker scenario," said Mark Zandi, chief economist with Moody's Economy.com. If banks tighten lending standards further, denying loans to borrowers with good credit histories, affordability won't be enough to keep people buying homes. And a sharper housing bust would leave deep scars in consumer sentiment, which would likely lead to a deep recession.
Analysts at Credit Suisse estimate that the S&P Case-Shiller Index of house prices in 20 major cities must fall by another 14 percent for houses to become affordable again, assuming the typical mortgage rate stays around 6.32 percent. The index was down 15.8 percent from a year earlier in May.
If borrowing costs eased to 5.5 percent, the Case-Shiller index may have only another 7 percent to fall, Credit Suisse said, but if rates rise to 7.5 percent, house prices may tumble another 24 percent.
A 24 percent decline would wipe out the entire home equity for millions of homeowners, many of whom were counting on their homes to finance their retirement or pay for their childrens' college education. Without that nest egg, spending would suffer, triggering a consumer-led recession that some economists predict would be the worst since the early 1980s.
"If there's a consensus, it's probably that prices will fall another 10 percent between now and next summer, which would be 25 percent down from peak to trough," said Zandi of Moody's Economy.com. "Another 10 percent down would put prices back consistent with rents and incomes. That's a signal that housing affordability has been restored for most potential home buyers," he said.
Wall Street has already priced in such a decline, Zandi said, so that scenario could set up a healthy stock market rally and ease the pressure on banks as well as Fannie Mae and Freddie Mac.
GLIMMERS OF HOPE:
Some investors saw cause for optimism in the most recent Case-Shiller index, which showed that home prices actually rose in May in seven of the 20 cities tracked, and the overall pace of decline was more modest than in the previous month.
Prices were still down from a year ago in each of the cities tracked, but they rose slightly from April to May in places including Boston, Dallas, Denver and Portland. However, the regions at the epicenter of the housing downturn show little sign of improvement. In Los Angeles, prices were down 1.9 percent month over month. They were also down in other well-known trouble zones including Miami, Las Vegas and Pheonix.
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