Studies show that consumer confidence and thus consumer spending is highly correlated with housing prices. The true “wealth effect” is not in stocks, but in homeowner equity.

Studies show that consumer confidence and thus consumer spending is highly correlated with housing prices. The true “wealth effect” is not in stocks, but in homeowner equity.

Thus, as home values continued to rise throughout the recent bear markets and recession, consumers were not as worried as in past recessions, and therefore barely skipped a debt-financed consumer spending binge. The Fed helped foster this mood by creating the climate for ever lower mortgage rates. Let us make no mistake, housing prices are linked to two key factors: demand and interest rates. Demand, it seems, is also spurred on by lower mortgage rates.

Since much of our future economic well-being is mortgaged to the housing market, it will serve us well to look at a few facts.

Let’s go to the Web site of the National Association of Realtors to see what we can glean from existing home sales. First, we went on a buying binge as a result of the low rates of this summer. Home sales peaked at a seasonally adjusted all-time high of 6.69 million homes per year. Looking at third quarter data, it seems we were buying at a pace of 7.4 million homes per year. This was up from a pace of 6 million only a few years ago.

This pace has dropped in the last two reporting months, declining over 9 percent from

September’s peak and back toward the still-high numbers from 2001. The average supply of existing homes for sale has grown from a 4.3 months to 5 months in just the last two months. But is the glass half-empty? Even dropping 9 percent, the pace was still 6.9 percent above that of last year.

Interest rates are roughly where they were at the beginning of the year. But the drop in the summer to 5 percent mortgage rates clearly spurred a huge increase in buying. The national median existing-home price was $170,900 in November, up 5.9 percent from November 2002 when the median price was $161,400. The median is a typical market price where half of the homes sold for more and half sold for less. That sounds good for homeowners, but housing prices declined in November, the fourth straight month during which prices did not rise and a cumulative decline over that period was nearly 6 percent.

Will housing now return to more “normal” levels, but still stay relatively high? If it does, then the seemingly ever present annual increase in housing prices should continue. But what if the slowing of demand continues? At some point, weak demand will halt the pace of increasing housing prices.

John Mauldin is publisher of Investors Insight.

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