The extent of eventual housing problems is highly dependent on the outlook for the economy and the future path of housing prices.  Fortunately, aggressive monetary and fiscal policy actions have been taken to help mitigate some of the downside risk.  These policies will likely result in some pick up in economic activity in the second half of this year, which should help to stabilize the housing market.

As noted earlier, the rapid rise in delinquencies for home equity lines and junior liens held at banks is occurring despite an unemployment rate of about 5 percent – so, should the unemployment rate rise and housing prices continue to fall, financial stresses caused by the housing correction could well spread beyond the large banks involved in complex securitizations, and the smaller banks with sizeable portfolios of construction loans, to a larger set of financial institutions. 

Research suggests that it was not so much interest rate resets that triggered the rise in subprime problems, as many expected. Indeed, reductions in short-term interest rates since the onset of the crisis should diminish the danger of foreclosures from such resets going forward. Rather, the single most important determinant of the level and change in subprime delinquency rates has been the pace of house price changes.

The outlook is indeed really sensitive to real estate prices. [Lower prices could cause a downward cycle and] that kind of adverse feedback loop is a real downside risk for the economy.

From audience Q&A as reported by Market News International.

My central tendency forecast is for the majority of markets to stabilize toward the end of this year and the beginning of next year, though in some regions it will take much more time.

From Q&A as reported by Market News International and Reuters

There were many different factors that led to a certain frothiness in the housing market, and these varied from region to region. There were a lot of local factors, not just national ones.

From Q&A as reported by Market News International

[The mortgage crisis] is bad and it's getting worse.

As reported by Bloomberg News

We have been pushing [mortgage servicers] to help more struggling homeowners avert foreclosure. It is our feeling, I will state very bluntly, that not enough is being done.

[The Fed is] pushing the industry to consider principal writedowns on these loans, and we have met with a lot of resistance.

As reported by Bloomberg News

The demand for housing is not likely to rebound substantially for a while after this episode, but the drag on growth from declining activity and prices in the housing market will ebb as excess inventories are worked off and affordability improves.

As with any forecast, mine is subject to a number of uncertainties. One is the extent of the housing correction ahead of us. If the retrenchment in house prices becomes deeper than anticipated, its effect on lenders and financial markets could further damp overall economic activity. We are in uncharted waters when the financial system becomes so disrupted, though we should consider ourselves fortunate that we have very few similar historical episodes on which to base our judgments. In such circumstances, uncertainty about how credit conditions will evolve and how businesses and households will react to changing terms and conditions means that we can have even less confidence than usual in our economic forecasts.

In retrospect, the breakdown in underwriting can be linked to the incentives that the originate-to-distribute model, as implemented in this case, created for the originators. Notably, the incentive structures often tied originator revenue to loan volume rather than to the quality of the loans being passed up the chain. This problem was exacerbated by the bubble in house prices: Lenders began to ease standards as further appreciation in house prices was expected to ensure that risk was low, and investors failed to perform the research necessary to fully appreciate the risks in their investments, instead relying on further house price appreciation to prevent losses. The interaction between lenders' and investors' views and house prices illustrates the pernicious feedback loop I highlighted earlier.

I don't want to hazard a guess that it's, oh, around the corner ...  If you look at the charts, the lines are headed south. Most measures of inventories look like they're going up.

As reported by Market News International, on whether an end to the housing downturn is near.

Looking ahead, our outlook at the Chicago Fed is for continued weakness in real GDP over the near term. Activity is likely to remain weak for a number of reasons. Strains on intermediation and financial balance sheets mean that credit conditions will likely continue to restrict spending for some time. Businesses and consumers could limit their discretionary expenditures because of caution over the economic environment. And housing continues to be a downside factor. The unsold inventory of homes will continue to restrain residential investment, and it will take time for this overhang to unwind.

However, eventually the cumulative adjustments in house prices will bring more buyers into the market and activity will stabilize. While we don't expect any significant contributions to growth from residential construction for some time, the drag from the sector ought to at least diminish as we move through the rest of this year and next. Similarly, as financial market participants revalue portfolios and repair their balance sheets, the drag from credit conditions ought to diminish over time. Furthermore, even given the financial turmoil, the stance of monetary policy is accommodative and supportive of growth. Productivity growth, although below the lofty rates enjoyed in the late 1990s and earlier this decade, is still solid. Finally, the effects of the fiscal stimulus bill are likely to boost spending in 2008.

The bottom line is that construction spending and house prices seem likely to continue to decline well into 2009.

This grim trio—the credit crunch, the deflating housing bubble, and the rising price of commodities—has combined to weigh heavily on demand by both consumers and businesses.