Home Price Declines Becoming Less Jarring

A closely watched gauge of the housing market provides encouragement. But will it prove short lived?

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While still falling at a double-digit clip, annual home price declines have eased off the breakneck pace we endured several months back. The S&P/Case-Shiller Home Price Index for 20 major U.S. cities fell 11.3 percent in August from a year earlier. That's a significant improvement from the January reading, which showed a 19 percent year-over-year drop in property values. "We have seen a very nice deceleration in the pace of [home price] declines," says Zach Pandl, an economist at Nomura Global Economics. "It really does look like price trends in the housing market have turned a corner and are improving—but I think we need to wait a little bit before calling the bottom." Here are four things you need to know about the development:

[Check out Home Building Figures Come in Weaker Than Expected.]

1. Less precipitous drop: The 11.3 percent year-over-year drop that the 20-city composite posted in August was the smallest such decline since January of 2008 and modestly stronger than the 11.9 percent drop economists had expected. It represents an improvement from July, when prices fell 13.3 percent from a year earlier. "While many of the markets remain down versus this time last year, the relative rate of decline has shown some real improvement," David Blitzer, the chairman of Standard & Poor's index committee, said in a statement accompanying the release of the figures.

2. Attractive prices, mortgage rates: The improving rates of home price declines are linked to the home selling market, which has firmed up in recent months. A number of factors, including cheaper home prices and attractive mortgage rates, have made buyers more comfortable making the biggest financial transaction of their lives. Thirty-year fixed mortgage rates, for example, averaged 5.45 percent in the week that ended August 14, down sharply from 6.65 percent a year earlier, according to HSH.com.

[See Mortgage Rates Seen Below 6% Through 2010.]

3. First-time home buyer tax credit: Home sales, of course, are also being juiced by the $8,000 first-time home buyer tax credit that President Obama signed into law in mid-February. Mark Zandi, chief economist at Moody's Economy.com, says the tax credit will be responsible for as many as 400,000 additional home sales by the time it expires at the end of November. (Many economists, however, consider the tax credit an inefficient use of taxpayer funds.)

[Check out First-Time Home Buyer Tax Credit: All Sorts of Sketchy Claims.]

4. Trouble on the horizon? Despite the improvement in home price declines, Alec Phillips, an economist at Goldman Sachs, expects property values to come under renewed downward pressure in coming months. For one, the first-time home buyer tax credit is set to expire at the end of November. And while Congress may push the deadline back, it's unlikely that the tax credit will be extended past the first half of 2010, Phillips argues. At the same time, the Federal Reserve's asset purchase program, which has played a crucial role in keeping interest rates attractive, is scheduled to expire at the end of the first quarter. And while foreclosure prevention initiatives—such as Uncle Sam's sweeping mortgage modification effort—may be keeping struggling borrowers in their homes for now, such programs may increase the number of distressed properties that will hit the market in the coming months. In addition, the unemployment rate could hit 10.5 percent next year, sucking further demand out of the housing market.

On account of these factors, "the risk of renewed home price declines remains significant," Phillips says in a report. He says home prices could decline another 10 percent by the middle of next year. "However, the cloudy policy outlook adds to our already considerable uncertainty of where house prices will ultimately bottom," he says.