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Let me tell you a TRUE STORY about this Wall Street banker who was talking to some homeless dude outside his office…

“I’m telling you, man, this place is going to be developed like crazy! Everyone is looking for a second ‘vacation’ home! Housing prices have nowhere to go but UP! I’m telling you – invest now! Don’t worry, the bank will give you a loan – it’s as easy as pie!”

As we all know by now… the unprecedented rise in housing prices from 1997 up to 2006 was completely unsustainable and a correction would take place sooner or later. Come March 2007, home sales plunged a whopping 13% and the price dropped 6% from the year before! This caused a record number of defaults on home loans and foreclosures, which caused a wide-reaching ripple effect across the economy.

Why would people pay their mortgage on something that has devalued? To exacerbate the mess, a large number of homeowners were unable to pay the loans they took out when subprime mortgages returned to regular interest rates.

Fast forward to the present… August 2009.

Am I seeing things…? Are things actually… improving? Could it be that Uncle Sam’s (in)famous economic stimulus package is… working? Are the government’s hefty tax cuts and massive house price markdowns finally starting to work their magic?

Let’s do a little investigating…

Existing home sales have made notable advancements, showing a clear 4-month long uptrend starting May 2009. Home sales dipped to a low of 4.49 million at the onslaught of the financial crisis in October 2008 and its behavior has been, more or less, erratic since then. A total of 5.03 million in existing home sales are expected for this July and if the actual data meets or exceeds the consensus, then we could chalk up another month in the current uptrend.

Pending home sales have also marked consistent gains for the past few months. There was even a 3-month period starting March 2009 when pending home sales posted increasing gains. This surge was cut short in June when pending home sales recorded a mere 0.1% uptick… A bit disappointing, yes, but it is still on the positive end.

Meanwhile, building permits and housing starts both sank by 10,000 in July, dropping to 560,000 and 580,000 respectively. Despite the unexpected declines, analysts concluded that building permits and housing starts have bottomed out and are making baby steps towards recovery. Building permits reached a high of 1.09 million in June last year before dropping down by more than 50% and forming a “bottom” from January until April this year.

Housing starts are also expected to stage a U-shaped recovery, which scored a seven-month consecutive decline that started in July 2008. It reached a low of 460,000 in April this year before going on to record marginal improvements in the succeeding months.

Given that the housing industry was at the heart of this financial brick-down, how have industry players reacted to its developments? Since the start of this recession, we have seen investors run to the shelter of the USD and JPY when things were bad. In March, however, there has been a surge in equity markets everywhere, as investors have been looking for higher-yielding assets…

Interestingly, wasn’t it March when the US existing home sales came out much higher than expected? A look at the charts shows that the dollar dropped upon the release, as high yielders dominated the marketplace. It seems that good news from the US housing market may be a source of fuel for risk appetite.

Based on the latest data, the US housing industry has been showing real signs of improvement as of late. But how would it fare come December 31, 2009? To answer that, let me go over one factor that is dampening the growth of the housing market – unemployment.

Despite the unexpected improvement to 9.4% from 9.5% in the unemployment rate last month, dismal labor market conditions continue to put downward pressure on consumer spending. The average hourly earnings for the same period showed a 0.2% increase.

Still, the previous week’s personal income report revealed that workers were getting 1.3% less of their total income indicating that firms simply cut back on the working hours to save some workers from losing their jobs.

The bottom line is, even with the improvements in the labor market, purchase for high-ticket items, such as housing remains muted. Of course, how can one spend on things if they don’t have any income? If a person is forced to cut back on clothing and cars, what more a house?

Just today, the IMF announced that we are “out of the recession” already. While improving confidence in the markets may prompt consumers and businesses alike to spend and expand a little more, the underlying weakness in the US labor market will put a drag on the industry’s growth. Unemployment fears, I believe, could “bring the house down.”