The drop in home price appreciation (HPA) was the crash that preceded the current economic pileup, figuratively speaking. With the expected recession intensifying the unemployment rate in the U.S., the HPA decline might be further exacerbated despite the Federal Reserve's attempts to curb payment shock.

In the past, whenever housing has done poorly, it has been preceded by a rising unemployment rate, said Ajay Rajadhyaksha, head of U.S. fixed income strategy at Barclays Capital. For example, after the end of the cold war in 1989, and with the closure of many defense bases in California leading to the loss of 150,000 jobs, the unemployment rate rose to approximately 9%. Not long after, home prices began to drop and California was hit with a housing bust.

However, this time it has been different, Rajadhyaksha said, noting that home prices started dropping before the unemployment rate has began to rise. "A 4.9% unemployment rate is still low by historical standards but home prices have already started to drop. Now if the unemployment rate starts to rise, it will hurt the housing market to a much greater extent than at any point in the past."

In a recent research report, Credit Suisse analysts said that home prices for large metropolitan statistical areas (MSAs) might need to drop 20% to 40% in addition to declines they might have already suffered. This includes areas like Phoenix, with a peak-to trough estimated decline of 36% and Miami, with a peak-to trough estimated decline of 40%. Areas of Southern California might also be affected, including Los Angeles that has an estimated peak-to trough decline of 26%. Nationally, the additional HPA decline could be in the teens, Credit Suisse said.

Using U.S. income growth and long term mortgage rates, analysis shows that for most MSAs the majority of home price declines are yet to come, "and borrowers will be under increasing stress as equity continues to be squeezed and refinancing opportunities dry up," Credit Suisse said.

Barclays currently estimates a national HPA decline of 8% to 10% over the next two to three years with much of the decline concentrated in the west coast.

Out of the 20 MSAs that make up the Case-Shiller 20-City Composite Index, 14 posted their largest single monthly decline on record in November when the latest survey was taken, according to a recent report from Citigroup. Charlotte, Portland, and Seattle still show positive year-over-year HPA. However, October to November month-over-month HPA was more negative than September to October month-over-month HPA for these cities. Year-over-year HPA for Detroit, Las Vegas, Los Angeles, Miami, Phoenix, San Diego, and Tampa has fallen in excess of 10%, Citigroup said.

While mitigating factors include the Fed's rate cut, which has diminished the reset shock, as well as the fiscal stimulus package, which will provide an initial boost of $100 billion for the country as a whole, there is no magic bullet, Rajadhyaksha said, noting that HPA is unlikely to get much better in the near term.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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