The Harvard Joint Center for Housing Studies recently released its annual State of the Nation's Housing report for 2007. It is dismal reading.

While it states that the longer-term outlook for housing is (more) upbeat, the length and depth of the current correction will depend on the course of employment growth and interest rates, as well as the speed with which builders pare down excess supply. The influx of immigrants and their children has and should continue to drive household growth between 2005 and 2015 and, with the enormous increase in household wealth over the past 20 years, healthy income growth will help propel residential spending to new heights.

The report reprises the run-up in housing demand and prices over the last few years, placing much of the responsibility for both with falling interest rates and the increased and probably inappropriate availability of credit in many sectors of the market.

The State of the Nation's Housing pegs the beginning of the downturn to late 2005 although it didn't show up in most economic reports until mid 2006. According to the Joint Center by late 2005 the combined impact of rising mortgage interest rates and higher house prices were beginning to force buyers out of the market. Magnifying the problem was a growing number of foreclosed homes returning to the market and investors seeing the end of the big show, beginning to exit the market. At this time builders pulled back hard on production but "the retrenchment came too late."

By the third quarter of 2006 the correction had begun to spread to numerous metropolitan markets and 277 of these registered a falling rate of housing permits in the fourth quarter of 2006 compared to the fourth quarter of 2005. 74 of the 148 metro areas studied by the National Association of Realtors' (NAR) showed a year-over-year decline in median home prices.

The report notes that, now that the downturn is in full swing, the question of its depth and duration hangs over that market. While the economy, interest rates, and credit availability will pay major roles in the outcome, so will the rapidity with which builders can work off excess inventory.

The number of vacant homes for sale jumped by one-half million between the end of 2005 and the end of 2006 but this figure may be misleading as some seasonal or occasional use home may have been taken off the market until conditions improve.

Assuming this oversupply "overhang" as the study calls it, is correct, this means that demand for new homes was running about a quarter-million units below the 2 million plus production in 2004 and 2005. This translates to a sustainable demand for houses of about 1.9 million homes during that pre-slump period. As this was about the number of homes built (or in the case of manufactured housing, placed) last year, no progress is being made toward cutting inventories. Any meaningful progress in this area would require that production falls to 1.66 million and it would take at least two years to work off the excess inventory. "In the most pessimistic view, the overhang may exceed 1 million units, meaning some rental vacancies may need to be worked off as well."

But yet, the report concludes, the potential impact of the slowdown on consumer and remodeling spending hasn't quite hit. Home prices are bound to soften further as they follow the downturn in home sales and starts; homes will stay on the market for longer periods, and motivated sellers, builders, and investors will reduce their prices. This process only began in late 2006 and then only in some locations. It has a ways to go.

With house prices no longer appreciating at a break-neck price, the risks inherent in subprime lending products will increase. As more and more borrowers risk losing their homes to foreclosure an accompanying problem is the number of mortgage companies that have been and will be driven into bankruptcy and those that will increase their reserves against losses.

But the study emphasizes the growing lack of affordability of housing in the United States. The stagnant income growth among those households in the bottom half of the economic distribution as well as restrictive land use regulations which discourage production of lower cost housing are both responsible for forcing up home prices and rents. While federal tax credit programs contributed to the addition of about 133,000 new and renovated units in 2005, the supply of affordable rentals continues to shrink.

In one telling graphic, a map of the United States is colored to reflect the hourly income necessary to afford a home - rented or owned - across the country. With the exception of pockets along the coasts and in resort areas in Colorado and the Southwest where incomes of up to or in excess of $21.75 are needed to afford even modest rentals, the map is a uniform grey indicating a required income of $7.25 to $14.49 per hour. The federal minimum wage is currently $5.15 per hour although many states have implemented higher rates. Even when or if the proposed new federal wage is fully phased in it will not cover the bottom end of this requirement given only one income earner in the household.

And, Harvard says, the pressures of high housing costs are moving up the income scale. Severely cost-burdened households in the bottom expenditure quartile had only $436 a month to cover all other non-housing needs in 2005. This is not a lot to feed, clothe, school, and provide transportation for even the average family of four. Because of these housing costs, more and more people are resorting to long commutes or moving in with other family members. The study does not address the possibility that households are trading heat, food, and certainly health care for shelter.

Federal assistance to very low-income householders is currently reaching only about 25% of renters and virtually no homeowners. Without some commitment from state and local authorities to lower the barriers to affordable housing the prospects for a reduction in the numbers of households that are suffering from housing cost burdens is not likely to improve.

So, what of the future of housing? The study concludes that it is too early to make many guesses. Prices have just begun to soften, risky loans are just now hitting reset dates, and lenders are beginning to tighten credit standards. Still, no matter how long it takes, the market will eventually recover. "Once excess inventories and credit problems are worked out and balance is restored, ongoing demand for new and improved homes promises to lift the value of new construction and remodeling to new highs. Greater productivity will help raise real incomes for many while record wealth will allow households to spend more on housing." And, house prices will continue to move up.