Though October housing starts only fell marginally from the September figures, analysts predict lower levels going forward, and if mortgage rates continue to trend up this may be a cause of real concern for a thus-far robust housing sector.

According to experts, the housing sector typically falls off drastically by about 15% to 20% or more in a recession. However, that has not really happened in the current economic downturn, in large part because mortgage rates have continued to drop.

"As has been the case throughout the year, falling mortgage rates seem to be mostly offsetting deteriorating economic fundamentals such as rising unemployment, slowing economic growth, and sagging confidence," said Steve Stanley, senior market economist at Greenwich Capital Markets.

But if mortgage rates continue to rise, this might cause the housing market to decline substantially because the one piece of the market that has held up best over the last six to nine months, said experts, is the low-end. The low-end consists of first-time home buyers who are said to be the most sensitive to declining mortgage rates.

Decline in building permits: a bad sign?

Though the trending down in housing starts was considered only marginal, building permits have gone down rather substantially in comparison. Housing figures show that building permits went down from 1,571 in August to 1,473 in October.

Analysts say that building permits may not be as good an indicator of housing starts as they were about ten years ago, when permits tended to lead starts, because it took time for builders to get all the paper work in line. This is why people used to look at permits as a lead indicator that predicted starts.

According to Greenwich's Stanley, this relationship has kind of broken down recently, as efficiency gains have helped builders to get permits almost at the same time they start construction. In fact, there are localities that do not even require permits before building.

Though acknowledging that permits have not been an accurate predictor of starts in recent years, Stanley said that "it certainly bears watching and confirms that there is significant downside risk in the coming months."He added, "Through early November, plunging mortgage rates have provided support to demand for homes, but the recent abrupt reversal in rates, if it continues, could undercut the only clearly supportive factor for the sector at a time when unemployment is rising rapidly and consumer confidence is at or near multi-year lows."

National Association of Home Builders (NAHB) economist Michael Carliner said that the downward trend in building permits is consistent with NAHB's expectations that there would be a lower level in starts.

Modest decline expected

Carliner said that the NAHB is expecting a relatively modest decline in housing starts going forward.

He stated that one of the major factors contributing to this is the favorable mortgage rates which, even if they have ticked up a bit, are still better than they have been historically.

In addition, he said that when this point in the cycle is reached, there are usually problems with the inventory of unsold homes. However, the inventories currently have been very lean, so NAHB does not anticipate any inventory adjustments to exacerbate the decline in starts.

According to Stanley, small declines in the housing arena are expected as long as the economy is deteriorating, but this is predicated on the idea that mortgage rates are going to stay fairly low. He said that if there is a real back-up in mortgage rates on top of continuing economic deterioration, this would lead to larger declines in the housing sector.

However, he stated that the process is self-correcting because as the economy gets weaker, mortgage rates usually dip further.

Stanley stated that a more realistic scenario would be that the housing market would only erode, rather than fall apart, over the next three to six months.

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