"A Cooling Trend" was the title given to Freddie Mac's September 2006 Economic Outlook released recently. In keeping with the seasonal theme, the report, issued by the Office of the Chief Economist, projected a cooling trend for the balance of the year, "with occasional frost and warmer conditions as we move into next spring."

Too cute by half, but the report goes on to emphasize the importance the housing sector has been to the overall economy during the recovery from the 2001 recession. In fact, more and more it looks as though it was not an economic recovery as much as it was a housing boom. During the period from quarter four of 2001 though the same quarter in 2005, real residential fixed investment (RFI) grew at 8.4 percent annualized while the real gross domestic product grew at 3.0 percent. Employment growing out of construction, home selling, and mortgage lending was responsible for 2 out of 5 jobs created during that four year period. It has long been clear that housing was driving much of the recovery but this states it as baldly as I have ever seen.

So now that housing is slowing down, the drop in housing starts and home sales has pulled RFI down in each of the last two quarters to a rate of 5.2 percent when annualized for the first two quarters of 2006. The forecast says that economic growth short term will be sustained by growth in business investment spending and consumer spending and that the consumer spending is still being fueled by home equity wealth.

It would seem that home equity wealth will necessarily also start to wane as house price appreciation returns to normal levels so I guess we have to hope that something will take up the slack. House price appreciation was at an annualized rate of 15.4 percent during the second quarter of 2005; during the second quarter of 2006 it was 4.9 percent.

But the country is still looking at the third best year ever for the housing industry; 2004 and 2005 hold the record. Home values are still increasing in most places and eight out of nine home financers continue to pull equity out of their homes.

The narrowing gap between fixed rate and adjustable rate mortgages will continue to drive consumers toward fixed rate products which, given the concern about rate shock, is a good thing. The report projects that ARMs will move from representing 25 percent of all mortgage originations in Quarter Two of 2006 to 21 percent by the end of the year.

Mortgage originations are expected to be "frosty," i.e. at the lowest rate in six years as adjusted for inflation, but "a spring thaw is expected" as the housing market lands softly.

The forecast noted that mortgages rates have dropped nearly 40 basis points from mid-summer highs and projected an average for the 30-year fixed-rate mortgage of 6.5 percent in the second half of the year with fluctuations as high as 7 percent. This 6.5 average is down one basis point from August expectations.

Housing starts were down 2.5 percent in July alone and are off 13 percent since July 2005 while sales of new and existing homes dropped 4.3 and 4.1 percent respectively in July. Both starts and sales are expected to trend downward over the remainder of this year and all of 2007. The forecast, however, suggests that this drop will not continue at the accelerated July rate. Starts are now expected to total 1,860,000 this year, a retrenchment from the 1,900,000 forecast in August while total home sales, both new and existing, are projected at 6,870,000, somewhat less than the 6,900,000 estimated last month and 2007 sales are expected to total 1,710,000 a little less than the 1,730,000 in the August forecast..

Home price appreciation reflects the softening demand for housing and the increased inventory of homes for sale. Appreciation was down to 4.9 percent in the second quarter and is expected to finish the year at an annual average of 6.7 percent - a decided contrast to the 13.3 percent appreciation recorded last year. It is also a decline of 0.4 percent from the annual appreciation projected by Freddie Mac last month.

We have learned over the months that this report is most informative when its more important projections are read side by side over several months. In this light it appears that the housing bubble may be deflating a little faster than Freddie Mac expected even one month ago.