Housing starts were down a year-on-year 20.6 percent in August reflecting the glut of homes on the market. Supplies of new and existing homes have been swelling over the past several months. You have to go back again to the mid-90s to find comparisons as weak as the current trends.

But it's important to remember that the housing market has grown sharply over the last five years. Actual levels of sales, in contrast to the direction of sales, are in fact robust. As shown in the graph below, sales showed a four-year gain of nearly 40 percent at their 2005 peak.

Consumer drain
The graph below shows the strong appreciation in home prices over the past 11 years, with year-on-year percentage gains spiking to 25-year highs at mid-2005. But price appreciation this past year has come straight down, similar in degree to a fall in the early 80s that coincided with a recession.

The consumer has been relying heavily on high home prices to get by, specifically borrowing against rising equity value. Wages have lagged inflation for the last couple of years, savings have been contracting for a year-and-a-half, and mid-single digit returns is the best the stock market has done.

The downturn in home prices marks a key point for more than just the housing market. The more severe the downturn grows, the greater the risk to consumer spending. There's chatter in the markets right now that the drop in home prices is offsetting, as far as the consumer is concerned, the drop underway in gas prices.

Discretion essential
Investors and traders are specifically asking if home prices are crimping discretionary spending. But where to look for the first glimpse? Tuesday's consumer confidence report from the Conference Board showed wide declines in buying plans including for cars, homes, and appliances. Buying plans for TV sets, maybe the most discretionary of the Conference Board's categories, fell sharply to the low end of trend.

It's difficult in fact to find substantial economic categories that focus solely on discretionary items, no doubt a reflection of the difficulty to define the term. What's essential to one person, furniture to fill a new home, may be discretionary for another, furniture to fill a second home. But demand for new cars and trucks, highly subject to expense and often status appeal, gives us at least a chance to get a glimpse of the discretionary effect.

The slowing trend in home price appreciation in the graph above does track, to a degree, the slowing trend in auto sales with both posting for the most part declining rates of year-on-year growth. But the relationship isn't dramatic and the trend, if any, is at its beginning. The graph below compares home prices against all retail trade, loaded with less discretionary categories such as groceries and gasoline. But here the direction is also similar -- that is declining rates of year-on-year growth.

Bottom line
Keep an eye out for how abruptly the housing market slows. Speculative excess in the housing market was a concern in the final years of the Alan Greenspan Fed. The careful unwinding of the excess is proving to be a first test of the Ben Bernanke Fed.