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Over the past year, home sales have dropped by 22 percent, single family housing starts have plummeted by almost 35 percent, and nationwide, home values have slipped by about 4.5 percent.  Clearly it has been far from a normal year in the housing market, and 2006 was weak as well.  On the other hand, the several years before these were just as unusual from housing, but the opposite perspective.  So, just what is a normal year for housing, and will we ever see one again?

Historically, the housing sector has been one of the most volatile in the U.S. economy.  The reason for this is that to a large extent home sales are driven from year to year by housing affordable, which in turn usually is affected most strongly by movements in interest rates. 

Whether it is because of changes in monetary policy at the Federal Reserve, adjustments in inflations expectations, movements in foreign capital flows, or just increases and decreases in economic growth, interest rates tend to be volatile - thus moving housing demand up or down, often sharply.  In recent years this more normal interest rate volatility has been heightened by movements in house prices, resulting in sharp swings in affordability.

Are we nearing the end of the current housing downturn?  We dont think so, given the magnitude of the run up in housing (with no significant housing downturn since the recession of 1991-92).  That doesn't mean that the level of housing activity has to fall to 1992 levels - after all there are almost 22 million more households today then there were back then, with higher income levels and lower unemployment rates.  But the unsustainable surge of 2002-05 has to be worked off, and thats whats going on in the housing market today.

The famous economist Herb Stein once noted, "If something cannot go on forever, it will stop."  That is probably the best way to view the housing market today.  We know that given the cobmination of demographics, job and income growth, and the level of interest rates, housing demand cant fall without bounds.