How far down?

Michelle Meyer at Bank of America Merrill Lynch is looking for an additional 8% drop in home prices through the end of the first quarter next year, assuming the economy remains buoyant. That also assumes that the foreclosure overhang remains tolerable with an additional 8 million homes liquidated by the end of 2015.

The scary thing is Meyer's model is extremely sensitive to shifts in both the amount of housing inventory and the number of distressed foreclosure properties being sold. Her downside scenario, which would see prices drop an additional 20%, is based on inventory jumping to nearly 12 months' of supply by 2013. According to Rosenberg's calculations, we may already be close to that level.

An additional 20% decline would put the cumulative, post-bubble home price drop at 46% and return home prices to levels last seen in 2000. And the risk is that this weakness becomes self-sustaining, since additional home price weakness would pressure the banks to further tighten mortgage lending, pressure household spending via reduced wealth, and pressure the government via increased budget deficits as economic activity slowed.

So not only is the housing market far from "safe" by any traditional definition of the word, it's very likely that a double-dip in home prices could slam the brakes on an already feeble recovery.

Glimmers of hope?

It's not all black and blue. For one, any new recession would suffer a smaller drag from housing since construction activity is already low -- and is, in fact, rebounding because of rising demand for multifamily and apartment units. After all, people still need places to live even if they can't or don't want to be homeowners. And that explains why rental rates are now rising around 2.5% a year as vacancies fall.

(My motivation for buying was how this impacted the affordability of owning a home versus renting.)

The other over-the-horizon positive that should eventually stabilize home prices is simple human nature. Americans like to reproduce. And foreigners still want to immigrate to our shores. This demographic tail wind will keep demand for housing units on the rise.

Meyers quantifies this by looking at the household formation rate. It's been depressed lately as 20- and 30-somethings move back in with Mom and Dad and homes become increasingly multigenerational out of necessity. In a normal environment, around 1.2 million households are created each year. But in the past four years, this pace has slowed to just 500,000.

It isn't sustainable without a major cultural shift. We're the land of open spaces, SUVs that could double as urban warfare vehicles, value meals, and unshared bathrooms. And as people move out, they'll be on the prowl for cut-rate McMansions of their own.

Overall, Meyer's home price model shows home prices turning higher in 2014 (after overshooting to the downside) and returning to fair valuation by 2019.

That means the current excitement amounts to little more than another false dawn. Back in January 2010, Wall Street was looking for housing starts to average 1 million in 2011. But the actual pace was about 600,000. This year, initial forecasts were for 900,000 versus 700,000 now. Eventually, perception will catch up to reality as widespread investor pessimism sets the stage for an upside surprise in two years' time.

But we're not there yet.

At the time of publication, Anthony Mirhaydari did not own or control shares of any company or fund mentioned in this column.

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ETF and stocks mentioned in this article: iShares Dow Jones US Home Construction ETF (ITB), DR Horton (DHI, news), Toll Brothers (TOL, news) and Pultegroup (PHM, news).