The sharp increase in prices of homes during 2004 and 2005 helped households support their expenditures by enabling large mortgage equity withdrawals amounting to $544 billion in 2004 and nearly $600 billion in 2005.

The recent sharp drop in home prices has reduced the volume of mortgage equity withdrawals to an annual rate of $215 billion in the third quarter of 2006 (see chart 2) from a peak rate of $730 billion in the third quarter of 2005. This significant reduction has trimmed the pace of consumer spending. Further reductions in home prices are predicted to translate into soft growth in consumer spending in 2007.

Have home prices stabilized? Expert opinion is leaning toward a further correction in home prices. The median price of an existing single-family home fell in each month from August to November and posted a steady reading in December. The median prices of a new single-family home has dropped in three out of the four months ended December (see chart 1). The OFHEO (Office of Housing Enterprise Oversight) price index moved up only 5.97% in the third quarter of 2006 compared with a year ago reading. The Case-Shiller Home Price Index of 20 metro areas was up only 1.7% on a year-to-year basis in November 2006.

President Poole of the St.Louis Fed made these remarks about home prices this morning: “My summary conclusion on home prices is that we have evidence of pervasive weakness last year. It remains to be seen what this year will bring, but at a minimum we can say that we do not have evidence as yet that home prices have stabilized.”

Professor Shiller noted, in The Wall Street Journal yesterday, that “although the CME housingfutures market is still relatively thinly traded, the prices there reflect the collective view of multiple investors, hedgers and speculators. The futures market still predicts home price declines in all traded cities over the next year, though modestly lower declines than in the recent past.”

He only comments that “these are only short-run indicators, and they do not tell us a lot about the major correction in home prices that might be in store. The fact that home prices have risen so high relative to construction costs and other indicators suggests that home prices might fall back substantially in some markets -- and maybe that is what is going on. But one can hardly be sure about whether and when it will happen. It could take many years for new construction to completely close the unusual builders' profit opportunity created by high home prices, and many unpredictable things could happen over that time.” “We are left with a deeply uncertain situation, but one in which it would seem that a sequence of price declines continuing for many years has some substantial probability of happening.” Professor Shiller’s article is available at (