Mark Zandi on the Housing Bottom

I just spoke with Mark Zandi, chief economist for Moody's Economy.com, informal adviser to John McCain's presidential campaign, and the author of "Financial Shock: A 360 Degree Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis." In our conversation, Zandi offered his outlook for the housing market.

Excerpts:

When do you expect housing prices to stabilize?
Summer 2009. Prices will fall another as much as 10 percent from their current levels. We are down 20 percent from their peak.

Why then? What are the factors behind that?
The key factor is a restoration of housing affordability because that is vital to housing demand. And I think it is going to take another 5 to 10 percent decline in house prices—along with another 5 percent increase in effective apartment rents—before we have affordability back to where it needs to be to restore demand.

How about inventory?
That is the second criteria. We need to get rid of all the excess inventory before prices start rising. And I think that won't happen until...the fall of 2010. It's going to take about two years to work off all the excess inventory... That two-year timeline, obviously, is dependent on the level of construction and underlying housing demand.

We are already seeing construction come off.
Right. In fact, we may hit a new post-World War II low somewhere in here over the next few months.

How important is that to stabilizing home values?
That is absolutely vital to working off that inventory.

How about the bear case? What could change to prolong the decline in home prices ?
Well, it could be that the job market erodes measurably more than anticipated. It doesn't really matter if house prices are affordable relative to incomes if you don't have a job. So, if the job market continues to erode and unemployment continues to increase—and I'm expecting a bad job market when I give you these projections—but if it weakens more than I expect, which is very, very possible, then the bottom in prices is further into the future and the day when they start to rise is well into the next decade.

What additional variables are at work here?
The other key variable is the cost and availability of mortgage credit. That could be plus or minus, particularly given the government takeover of Fannie and Freddie. If fixed rates stay below 6 percent, that's a great thing... But if for whatever reason that started to rise—who knows—then that would be a problem. Also, I think a lot depends on how aggressive Fannie and Freddie and the FHA can be in extending out credit later this year into next. And that would be very helpful if they could become more aggressive in extending out credit. If they can, that could ensure that my forecast comes true.