With the economy expected to rebound in the second half of this year, home sales are also expected to go back up to near-record or record levels during this time period, said economists at the National Association of Realtors (NAR).

But despite the anticipated strong third and fourth quarter showing, the NAR expects about a 3% decline in new home sales and about a 1% drop in existing home sales for the year as a whole.

However, this should not be taken as a sign of a deteriorating housing sector. The situation now is quite different from previous recessions, where housing activity dipped significantly and then made a strong comeback as soon as the economy recovered. In the current downturn, housing remained robust despite the deterioration of other economic indicators.

So, in effect, there is less of a push for an upward movement in the housing numbers. Aside from this, "a lot of buyers or potential buyers already purchased homes last year leaving very small pent-up demand for this year," said Lawrence Yun, senior forecast economist at the NAR.

Fannie Mae expectations

Like the NAR, Fannie Mae does not expect home sales to drop drastically this year compared to 2001.

According to Fannie's chief economist David Berson, housing sales are going to remain virtually unchanged from where there were last year, except for a slight dip.

For the first half of the year, recent purchase index numbers from the Mortgage Bankers Association (MBA) -- which are a good indicator of home sales two to three months ahead -- show no signs of weakening. In fact, January purchase applications were at an all-time high and though the numbers are slightly lower in February, they are still at a level that indicate that home sales in coming months should be very strong. Aside from positive housing indicators in the first half of the year, two things are going to happen in the second half that would have the net effect of bringing this year's housing sales numbers close to last year's levels.

The first event is the fact that the economy is going to come out of a recession. In the second half of the year, there would likely be an improvement in the job market causing consumer confidence to come back, which is a definite positive for the housing sector. However, offsetting this would be a movement in interest rates.

"We don't think interest rates, particularly mortgage rates, will move up by much, but they will move up some compared to where they were in the second half of last year," said Berson. "By the end of the year, for example, you'd see the 30-year fixed-rate mortgage around 7.5%. This is still relatively low but it's about a full percentage point above where it was in the fall. So we have two things that are moving in opposite directions for housing: a better job market and higher mortgage rates."

Berson said that the net effect is that these two events would cancel out, resulting in home sales in 2002 being close to the record levels achieved in 2001.

Last year's data from NAR

Though last year can be considered a record year in the housing market, there was some slowing seen during the fourth quarter of 2001.

The NAR's most recent report on total existing-home sales indicated that the seasonally-adjusted annual rate was 5.92 million units in the last quarter, which is up by 2.6% from 5.77 million units over the same period in 2000. However, sales in the fourth quarter were down by 1% from a pace of 5.98 units in the third quarter.

The decline in the fourth quarter is associated with two factors. As mentioned above, due to the low mortgage rates, many first-time homeowners went to buy homes in the first part of last year. This left very little pent-up demand for the second half of 2001. This, in combination with the increase in the unemployment rate, caused the slight slowdown, explained NAR's Yun.

Home price appreciation

The NAR expects home price appreciation to increase by 4.5% this year, which is not significant considering that it has been growing at a pace of 8%-9%.

Aside from the weakening employment situation that has caused the recent decrease in housing activity, the projected dip in home price appreciation is caused by the expected rise in mortgage rates later this year.

Yun stated, "With economic recovery, investors would be shifting their money back into stocks and away from bonds and when that happens, that generally drives up the interest rate a little."

The slowdown in the pace of home price appreciation may have an impact on MBS.

In a recent report, Bear Stearns analysts said, "National home price growth is expected to slow from its recent pace of 8-9% to a more historically consistent 4% with pockets of significant price declines in areas heavily dependent on tech sector jobs. This could put pressure on credit-sensitive bonds in the second half of the year, particularly as deleveraging benefits begin to fade."

Allaying fears of extension risk

MBS market players have always been wary of a recession in the housing front. This is because with limited housing turnover, extension risk becomes a real possibility.

In the Dec. 3rd issue of ASR, experts warned that the risk from extension is not so much from just extending duration but it is more from a potentially significant decline in turnover rates.

However, experts say that extension risk does not currently pose an imminent threat.

"The real downside of extension risk has to be taken into consideration in relation to ultimate housing turnover," said an MBS investor. "If we get to a period like 1994 into 1995 where there were really low turnover rates then your extension risk is more of an issue and that hasn't materialized. It's probably ripe for being considered, just because it's been so long since we've been at those kind of very slow baseline speeds, but nevertheless the housing market remains pretty strong here."

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