The decimated housing market may get considerably worse before it gets better, according to housing-industry professionals, who expect foreclosures and home-price declines to continue pressuring the sector through at least the first half of 2010.

The biggest problem will likely be a flood of inventory hitting the market from rising foreclosures, says Bob Curran, a managing director at Fitch Ratings. With a mountain of specialized adjustable-rate mortgages, known as option ARMs and Alt-A mortgages, slated to reset over the next 12 to 18 months and unemployment projected to hit 10.5% this year, the number of homeowners defaulting on their mortgages is expected to surge. At least $64 billion in option ARMs will reset in 2010 and another $68 billion in 2011, according to First American CoreLogic, a real estate and mortgage-data company. 

At the same time, the government’s loan-modification program has been disappointing: the default rate on loans modified after the third quarter of 2008 was 61%, according to a report issued in December by the Office of the Comptroller of the Currency and the Office of Thrift Supervision. All of this is expected to trigger another wave of potential home foreclosures in 2010 and could cause home prices to fall another 5% to 10% before the market stabilizes, according to analysts and economists.

A record 3 million homes received foreclosure notices in 2009, according to Lawrence Yun, chief economist with the National Association of Realtors (NAR). He expects a similar number this year.

John Burns, president of John Burns Real Estate Consulting, is a bit more bearish, predicting foreclosure notices will rise to 3.1 million this year. Foreclosure notices include default notices, auction-sale letters and bank-repossession notices. But those notices may produce a far more damaging result than last year’s. “I think 50% more people will lose their homes to a bank this year than they did last year,” predicts Burns. 

One reason for the expected jump, he says, is that in 2009 many lenders were under pressure from the Obama Administration to postpone repossessions until loan modifications could be made. However, many banks didn’t have the staff to assess all their defaulted loans at the time, and he believes many of those will ultimately go into foreclosure in 2010.

Adding to the sector’s woes — the Federal Reserve has indicated it plans to end a program that’s helped keep mortgage rates at attractive levels for home buyers. The Fed program, which involved purchasing up to $1.25 trillion in mortgage-backed securities backed by Fannie and Freddie, will expire on March 31. Rates have already started to inch up in anticipation of the change, with the average 30-year fixed-rate mortgage surpassing the 5% mark in December.

Since the housing market’s peak in July 2006, home prices have plunged 30% on average, with prices in some markets, such as Las Vegas, Phoenix and parts of Florida, falling more than 60%. NAR’s Yun estimates home-equity losses from the housing meltdown totaled $7 trillion at the end of 2009.

Many housing-industry experts believe pricing will bottom soon, but the bears warn that it will probably be 2013 before the market noticeably rebounds. “The improvement that we’re going to see off the bottom will be anemic” for quite some time, says Curran.

“Some markets still have further [down] to go, but we’re definitely in the latter innings of the downturn,” says David Goldberg, an analyst at UBS. “Even if there’s another leg down, we definitely think by [late] 2010 we will have seen the bottom of housing.”

The government’s decision to extend the $8,000 first-time home-buyer tax credit to mid-2010 and expand the program to include a $6,500 credit for non-first-time home buyers will likely help lure home shoppers into the market. Also, the slide in prices is making homes more affordable. Notes Burns: “If you go to Phoenix, it’s $800 a month to buy a brand-new house,” making it more affordable than renting.

There have already been mixed signs of stabilization in price and demand. Home prices rose month over month for six consecutive months through October, according to Standard & Poor’s Case-Shiller Home Price Composite 10 Index, although prices are still down year over year. However, the most recent figures from NAR indicate that pending sales of existing homes fell 16% in November. Such mixed signals, analysts say, will be the housing market’s message for some months to come.

Time

NEW YORK (CNNMoney.com) — It appears 0% is here for the foreseeable future.

A year ago, the Federal Reserve took its key overnight lending rate, the fed funds rate, down to near 0% for the first time in its history in an effort to keep the economy from falling into depression.

The cheap money meant lower rates for consumers on credit cards and home equity loans, as well as for many business loans.

The threat of a depression is widely acknowledged to have passed and most economists believe the economy has begun at least a modest recovery. But the Fed hasn’t moved the rates since, and experts don’t think they’re likely to do so for the foreseeable future, perhaps not until 2011.

Fed funds futures on the Chicago Board of Trade, which track the key rate, show investors aren’t betting on a hike anytime next year.

Part of that is because of talk from Fed officials. Fed Chairman Ben Bernanke, named Time’s Person of the Year on Wednesday, has repeated frequently that one of the problems of the Great Depression was that the Fed raised rates too quickly when the economy first showed signs of life, causing a second, much more painful downturn that extended the Depression for years.

Economists say they think the chairman and many other policymakers are willing to wait too long to raise rates rather than risk hiking too soon.

“I think they’ll leave the taps open as long as possible, until they’re absolutely certain the economy is back on track,” said Anthony Michael, head of fixed income for asset manager Aberdeen’s Singapore office.

In recent statements issued after policy-making meetings, the Fed keeps cautioning that it expects economic conditions “likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

That language is widely expected to stay in place when the central bank concludes a two-day meeting Wednesday.

But leaving rates at such levels is not without significant risks.

Low rates can sow the seeds of inflation, which can eat into workers’ earnings and squeeze budgets. It also has been blamed for the fall in the value of the dollar versus other major currencies, such as the euro, which in itself can limit Americans’ buying power.

Beyond that there are concerns that cheap rates can feed asset bubbles. Many blame the Fed’s decision to leave rates at its previous record low of 1% for 12 months from June 2003 to June 2004 as a major factor in feeding the housing bubble. The low rates caused builders to overbuild, lenders to make riskier loans seeking better returns, and consumers to use the cheap credit to buy homes they ultimately would not be able to afford.

While another housing bubble is not likely, some are now worried about bubbles in U.S. stock and bond markets, as well as in some commodities such as gold. The Standard & Poor’s 500 has gained 64% since it hit a low in March.

All those fears have prompted some in the market to argue the Fed risks falling behind the curve if it doesn’t raise rates sooner rather than later. But others dismiss those fears.

“Am I worried about the Fed being behind the curve in raising rates? At this point I want to make sure there’s a curve,” said David Wyss, chief economist for Standard & Poor’s. He said a rebound in hiring could prompt the Fed to move as early as next summer.

But others think the Fed will wait until it sees both a pickup in consumer spending and inflation warning bells.

“The consumer is not a viable spender right now and won’t be throughout most of 2010,” said Jeffrey Burchill, chief financial officer for business property insurer FM Global. “If you’re not seeing spending, it’s going to be difficult to raise rates even if there’s early signs of inflation. Similarly, if you see spending but without signs of inflation, there’s no need to raise rates.”

While economists think there’s a chance the Fed could raise rates late next year, few would be surprised to see them stay on hold all the way through 2010. A survey of 48 top economists by the National Association of Business Economics foresees rates at current levels through the first quarter of 2011.

Part of the reason is the Fed has done so much more than simply cut rates to nearly 0% in an effort to spur the economy.

It has bought more than $1 trillion in mortgages in an effort to keep rates low and spur home sales and building. It also has bought hundreds of billions of Treasurys and debt issued by mortgage finance firms Fannie Mae and Freddie Mac. And it has offered a number of other programs designed to jumpstart lending to small businesses and consumers.

Many believe the Fed will have to sell a significant portion of those assets into the market before it is ready to raise rates

“There are too many things that have to happen before the Fed is in position to (raise rates) again,” said Kevin Giddis, managing director of fixed income at investment house Morgan Keegan.

By Chris Isidore

NEW YORK (Fortune) — The economic storm pelting the U.S. economy is going to do plenty more damage to already flattened job and housing markets.

But as dark as the next three or four quarters could be, the U.S. economy appears to be undergoing a more lasting, and ultimately uplifting, shift.

Americans who for decades have spent an increasing share of their incomes and taken on more and more debt are now, for the first time in years, saving instead.

The personal savings rate, which measures the amount of disposable personal income that isn’t spent, ticked up to almost 3% in the second quarter of 2008, after almost four years below 1%.

While Americans still aren’t going to win any awards for thrift – consumers save more than 10% of their paychecks in creditor nations such as Germany and Japan, for instance – the return to saving carries big implications for U.S. economic health.

More saving is good over the long haul, because domestic savings create a pool of money from which companies can borrow to invest in new plants and equipment, creating the jobs that push living standards higher over time.

A growing domestic savings pool could also reduce America’s need to borrow money overseas – which would make the U.S. less beholden to foreign creditors who now supply us with hundreds of billions of dollars in financing every year.

Unfortunately, thrift will cost in the short run. Saving more means spending less – which translates into more hard times in retail and other consumer-driven businesses like the auto industry. The latest evidence of the shift came in Wednesday’s steeper-than-expected pullback in retail sales. They dropped 1.2% in September, in their first year-on-year decline in six years and only their third drop in the past 16 years. Economists had been looking for a 0.7% drop.

Given that two-thirds of economic activity is consumer spending, today’s thrift will exacerbate a general downturn and will weaken the impact of the massive interventions the government has made in the financial markets.

“The breadth of the decline shows a broad-based pullback in consumer spending that will not quickly turn around,” writes PNC economist Stuart Hoffman, “even with the arsenal of federal firepower now aimed at the Great Financial Crisis of 2008.”

Federal actions such as a $250 billion plan to buy preferred shares in banks, along with a public guarantee of bank deposits and bank debt, are aimed at unlocking credit markets and boosting economic activity. Policymakers have promised to get banks lending again, to restore economic growth that has clearly been ebbing even as government data chalked up modest gains in gross domestic product for the first half of the year.

“This plan is a means to an end,” Hoffman says of the Treasury’s agreement to make capital injections in banks such as Citi (C, Fortune 500), JPMorgan Chase (JPM, Fortune 500) and Bank of America (BAC, Fortune 500). “The key concept is that reasonably prudent lending should be supported.”

But as the economy shows further signs of deceleration – factory production and industrial capacity utilization fell sharply in September, the Federal Reserve said Thursday – the question is who the banks will be lending to. Indeed, merely plying the banks with capital isn’t certain to get them lending in a world in which businesses and consumers are trying to reduce their leverage after a long run of credit expansion.

William Cline, a senior fellow at the Peterson Institute for International Economics, notes that the decline of saving in the United States over the past two decades was accompanied by a sharp increase in the rate of bank lending, as consumers cashed in on the appreciating value of their houses.

Bank credit growth, after averaging around 6.5% in the 1990s, spiked to 12% in the four years ended in 2007, Cline says. Meanwhile the U.S. personal saving rate turned negative at the height of the housing bubble in 2005, down from around 7% in the early 1990s.

“We were already on course to have some return to saving,” says Cline, who is the author of the 2005 book, “The United States as a Debtor Nation.” With the credit crunch making consumer credit scarcer, he adds, and reduced house prices making Americans feel poorer, “We’re going to see some more pressure on household spending.”

For now, that will mean more pressure on companies that sell their goods to consumers. GM (GM, Fortune 500) and Ford (F, Fortune 500) have traded at multi-decade lows this month as U.S. auto sales slowed to a pace last seen in the early 1990s. Macy’s (M, Fortune 500) dropped 12% Wednesday after the department store chain cut its profit forecast, prompting ratings agency Moody’s to warn that further problems could prompt a costly credit downgrade.

The government interventions mean deleveraging can continue without the risk of an economic collapse, which is obviously “extremely positive” in the long run, says Ken Kamen, a financial adviser who is president of Mercadien Asset Management in Trenton, N.J. But that doesn’t mean the short run is going to be particularly enjoyable, as Wednesday’s 9% stock market decline suggests.

Kamen warns his clients that before they make any hasty decisions, they should decide how much stress they can tolerate in their portfolios.

“You don’t want to be resetting your financial future while the compass needle is spinning,” he says. “You may need to sell assets – but only to the point where you can sleep at night.”

The federal government’s multi-billion-dollar bailout of bad mortgage debt could be a game-changer for home buyers, sellers and real estate professionals.

But how much may not be clear for months, maybe even a year.

In the short term, according to Jay Brinkmann, chief economist for the Mortgage Bankers Association, the government’s plan to greatly expand purchases of mortgage backed securities by the Treasury, Fannie Mae and Freddie Mac, should “provide a signal to the market that there’s going to be an underlying floor on (interest) rates.”

That’s because when the Treasury buys mortgage securities — and it’s pledging $10 billion for this month alone, plus lots more to come – it has the effect of pumping fresh capital into the mortgage market, allowing more home loans to be made at more favorable rates.

Now, although rates should remain low, currently they’re close to 6 percent for 30-year fixed rate loans on average — that doesn’t mean it’ll be easier to qualify for a home purchase if you’ve got damaged credit or an income too low to pay for what you want to buy.

Those days are over for years to come.

What about the larger economic impacts of the bailout plan? Again, we’re at the earliest stages of this whole process, but if the plan brings a sense of stability to the financial markets, then, absolutely, the net effect should be to restore confidence.

And consumer confidence is an essential ingredient for a home buying recovery. People who are worried about the safety of their money market investments and bank deposits aren’t good candidates for purchasing houses — even at rock bottom prices.

But the reverse is true as well: Greater consumer confidence in the financial marketplace — along with modest interest rates and attractive prices — could kick the whole cycle into gear and get housing moving again.

There’s another factor here too: Without the big bailout plan, hundreds of thousands of financially distressed homeowners were on a non-stop conveyor belt to foreclosure. But when the government takes over mortgage portfolios, it’s likely there’ll be at least temporary halts to foreclosures and massive efforts to “work out” the terms of delinquent loans to enable owners to make payments at levels they can afford.

For neighborhoods hard hit by foreclosures — and the distressed owners themselves — that will definitely be a game changer.