The National Association of Realtors reported this morning that in December Existing Homes Sales plunged 16.7% from November, to an annual rate of 5.45 million. That rate was, however, 15.0% below the extremely depressed 4.74 million rate in December 2008. While inventories also dropped (as is seasonally normal), falling 6.6% on the month and down 11.1% year over year, the bigger drop in sales meant the months of supply on the market increased to 7.2 months from 6.5 months in November.

There are currently 3.29 million existing houses for sale in the county, down from a peak of 4.58 million in July 2008. So we are seeing some progress if one steps back and looks at the longer-term picture. The other good news is that the median price of a home is now $178,300, which is 1.5% above a year ago. However, care must be used when looking at median prices since they can be influenced by the mix of houses being bought and sold, which is probably the case this time around.

Home Sales Affecting Economic Conditions

It is important to point out that used home sales have relatively little affect on the overall economy. Their effects are mostly indirect, as people tend to redecorate when they move in. However, the economic activity generated by Sherwin Williams (SHW) selling a few more or fewer gallons of paint is pretty minimal relative to the economic activity generated by new home construction and sales.

The prices of existing homes are very important, particularly given the number of people who are already underwater on their mortgages, or are on the edge of becoming so. Being underwater on a house is probably the best single predictor of if the mortgage will continue to be paid, or if it will eventually go into foreclosure.

If someone has positive equity in their house, the foreclosure rate should be zero. Even if the person loses their job or faces some other economic calamity, if the house is worth more than the mortgage, selling the house is still better than having the bank take it. If the mortgage is more (particularly substantially more) even if someone had millions of dollars in the bank, it would still be economically (though there can also be non-economic considerations) irrational to continue paying the mortgage.

People not paying their mortgages is very bad news for the entire mortgage complex, from Fannie Mae (FNM) and Freddie Mac (FRE) to the mortgage insurance firms like MGIC (MTG) to the large banks like Bank of America (BAC).

While the decline was not expected by the consensus of forecasters — who expected existing home sales at a 5.90 million rate — it is not a total shock either. The pending home sales were weak, and much of this month’s decline is probably related to the near expiration of the first-time-buyer tax credit. When it looked like the window was going to close, there was a stampede of buyers trying to slip in under the wire, in effect stealing sales from future months. Come April, the tax credit is again expected to expire, so look for another round of fast buying followed by another hangover this spring.

Breakdown by Region

Why do I think that the mix has played a big role in the median price rising? Well, if we look at the regional data it looks sort of obvious. There are two high-priced regions of the country, the West and the Northeast. There, the median prices are $236,000 and $241,700, respectively. Over the last year, sales in the Northeast are up 21.3% (but down 19.5% from November) while year-over-year sales in the West are up 15.0% (down 4.8% from November).

There are also two lower-priced regions, the Midwest and the South, with median prices in December of $143,200 and $152,000. Over the last year, sales in the South are up 15.5% (roughly in-line with the West) but sales in the Midwest are up only 1.8%. Thus if sales are rising faster in high-priced areas than in low-priced areas, the median price is bound to rise. Relative to November, sales in the South were down 16.3% and in the Midwest they are down a whopping 25.8%.

Disappointing, but Not Shocking

All in all, a disappointing, but not shocking report, given the tax credit hangover. Again, keep in mind that new home sales are vital to the economy (indeed, traditionally the primary locomotive in pulling the economy our of a recession) but used home sales only have a minor overall affect.

The increased months of supply is probably the most distressing aspect of the report since it suggests more pressure on prices in the future. While that would be good for people who want to buy homes, given the leverage in the housing market, declines in nominal values are also highly dangerous to the system.

Over the long term, housing values have to be supported by incomes, and have to be reasonable relative to rents. With record high vacancy rates, rents are under pressure, while incomes are under pressure from 10% unemployment and 17% underemployment rates. If we are able to address the jobs problem, it would go a long way towards solving the housing problem, but there is a big element of “chicken and the egg” to that, given the historical role that new housing plays in economic recoveries. Used houses are a pretty good substitute for new housing, and if there is a glut of existing houses it does not make a lot of sense to build a lot of new ones.

Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market-beating Zacks Strategic Investor service.

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