The housing market has been in a serious decline for the last year. Sales are down and supply is at an incredibly high level. In the following articles, I'm going to break the housing market down into new and existing homes and detail the current environment for both market segments. I will be using some graphs from the website Calculated Risk which has done an extraordinary job of covering the housing market for the last few years. I will also be citing the blog Interest Rate Roundup another financial blog that has some great analysis.

First, let's look at new home sales.

The Census Bureau keeps track of the new home sales market, which has been in decline for the last year. Let's look at the long-term trend of new home sales. New home sales are expressed in the number of new homes that would be sold per year according to the current month's sales pace. Here is a chart from the St. Louis Federal Reserve's publicly available FRED economic database. This graph goes back to the early 1960s.

This chart has two time periods. The first is from the early 1970s to about the mid-1990s which is labeled "time period A". During this period, the rate of new home sales fluctuated between approximately 500,000 units/year and roughly 800,000 units/year (I'm eyeballing these figures). This range existed for about 25 years, indicating it was firmly entrenched in the US economy.

But notice what happened starting in the mid-1990s. New homes sales started to increase, really taking off at the beginning of the 2000s. At the end of the 1990s, the US economy was growing at a strong pace, the federal government was balancing budgets and the tech boom was in full force. These events increased consumer confidence, making consumers more prone to buying expensive items. However, the reason for the increase in the post recession economy of the 2000s was historically low interest rates. Here is a chart of the effective Federal Funds rate going back to 1970.

In the early 2000s the Federal Reserve lowered interest rates to the lowest levels in a generation. Because money was so cheap, any asset purchased on credit (such as housing) was now far more attractive. This is why new home sales increased to incredibly high levels for the first part of the latest expansion. Here's a chart of new home sales starting in 2000 to highlight the last 7 years of new home sales activity.

The main problem with the new home sales market is a huge inventory glut. The best explanation for the current situation comes from the blog Interest Rate Roundup:

Census data on new home inventory goes back to 1963. Prior to the latest down cycle, the highest inventory level recorded was 432,000 units in August 1973. Throughout the 1980s and 1990s, it was customary to have about 300,000 to 320,000 homes for sale, with peaks (in 1989 and 1995) of around 370,000.

This time around, supply has come down somewhat from the July 2006 peak of 573,000 units. But it's clear that we still have a major inventory glut -- something on the order of 150,000-200,000 units.

What makes it more difficult to clear this inventory glut is banks are tightening their lending standards making it harder for people to get a loan. Lending standards are tightening in reaction to the subprime mortgage fallout from earlier this year.

So, let's sum up the new home sales market.

1. From the early 1970s to the mid-1990s, new home sales fluctuated between 500,000/year and about 800,000/year.
2. New home sales started increasing at the end of the 1990s because of the overall economic situation, and continued at a historically high pace after the Federal Reserve lowered interest rates to generational lows in the early 2000s.
3. Homebuilders responded to the red-hot early 2000s new home sales market by building a lot more homes.
4. New homes sales starting declining in 2006.
5. Because of the decline in new home sales, there is now an inventory glut of new homes for sale
6. Starting in early 2007, banks and other lenders started to tighten lending standards, effectively reducing demand for new homes.
7. Because inventory levels are elevated by historical standards and it's harder to get a loan because of tighter lending standards, the new home market will be experiencing problems at least through the end of the year and probably longer.