The stabilization of new home sales can be credited to the combination of builder price discounts, improved affordability for homebuyers, the first time homebuyer tax credit and a variety of federal measures to reduce or delay foreclosures. The tax credit and foreclosure prevention measures will provide a further small boost in home sales in the next few months.  But the current record high home affordability is set to decline.

The recent improvements in both consumer income and credit costs are now reversing.  Income is being edged down by the spread of layoffs to high wage jobs accompanied by salary freezes, some wage cuts and, importantly, a large drop in contingent income, such as bonuses, commissions and profit sharing. The initial layoffs in the recession were heavily part time and low wage workers. An early summer wave of layoffs and wage cuts in the auto industry will add to income declines. Also, there have been two rounds of stimulus checks sent from Washington early in the recession. No more are coming. An up-tick in inflation will reduce real income more than nominal income.  Energy prices are rising again.  Inflation for imported goods will be rising in a few months following the 5% depreciation of the $US in May.

Long term credit cost trends have reversed. The yield on the 10-Year Treasury bond jumped 50 basis points in the last week. This is the benchmark for many mortgage rates.  Similarly, the yield on the 30-Year Fannie Mae Bond is up 50 basis point to 4.5% in the last week.  These changes have not yet reached mortgage rates but they will soon.

Why have interest rates for government bonds suddenly jumped while interest rates for private loans have increased much less? Washington has always assumed that it could it could borrow without lenders demanding a risk premium (for the risk of default) and could borrow as much as it needed without a major impact on the overall level of interest rates.  Neither of these assumptions is still accurate.

The recent massive increase in the scale of government borrowing is having a major upward impact on all credit rates.  Lenders expect the spending and borrowing surge to continue to fund pending programs to reduce carbon emissions and expand healthcare.

And for the first time, lenders are considering the possibility that the federal government may not fully repay it debts both because the debt has abruptly become much larger and because the actions of the federal government on residential mortgage repayments, the TARP program and the loans to Chrysler and GM suggest that the new team in Washington does not have an absolute commitment to debt repayments.