On the path to a housing rebound?

It's easy these days to get depressed about the news of falling home prices, sales and rising foreclosures, but Fortune editor Shawn Tully thinks it's also the sign of something different -- the seeds of a housing rebound in a very comprehensive article:

The news that housing starts have fallen to their lowest level in 17 years sounds like one more reason to be depressed about the shrinking value of your home. In fact, it's an almost certain sign that the path to a housing recovery is finally in sight.

If prices are going to stabilize, let alone rebound, the United States needs to produce far more first-time home buyers than new houses...

Builders constructed far more homes from 2002 until 2006 - the peak bubble years - than could possibly be absorbed by the normal growth in households.

As a result, the market is now swamped with one million new and existing homes for sale that aren't occupied, and hence need to sell quickly. That's a multiple of the figure in most downturns, and it testifies to the duration and girth of the bubble...

The massive overhang of unsold inventory has remained stubbornly high. Sure, builders cut back, but sales dropped just as quickly.

Now that excess supply is finally beginning to shrink. In April, the number of new homes for sale stood at 456,000 according to the U.S. Commerce Department, still a big number, but 93,000 below the mountainous figure a year ago...

The key player in any recovery scenario is the first time buyer. The housing market operates with a pronounced laddering or ripple effect. When entry-level buyers flood the market, they not only stimulate production of new homes, they purchase existing homes. Those purchases, in turn, allow the sellers to move up to bigger houses.

But when the first-timers are absent, the entire buying chain gets frozen.

Today, newbies are coming back. Why? For the first time in years, entry-level homes are affordable. Builders have slashed prices, and what they're building tends to be far smaller than the McMansions of the boom, selling for far lower prices...

Step 1: First, the return of first-time buyers will shrink the overhang of new houses for sale.

Step 2: Second, because so few new homes are being built, first-timers will start buying existing homes from owners who want to move up but have been trapped by the dearth of buyers. Their improved fortunes, though, come with a big caveat: The prices of new homes are now lower than comparably-sized existing homes. It's as if used cars are selling for more than new ones. That can't last. So move-up buyers are going to have to accept less than they had hoped to get for their current homes.

They'll get a big break as they trade up, however. Unless they bought at the height of the boom, they'll still sell at a profit. They can then use that equity to buy bigger homes at bargain prices. During the bubble, homebuilders started pushing up home sizes to 3,500 square feet or more. It's those behemoths that are selling for the steepest discounts today.

Step 3: Next, housing starts should start rising, probably next year. The increase, however, will be slow and gradual. For the next two years at least, homebuilders will compete ferociously with existing home sellers for customers.

Step 4: Eventually, the glut of existing homes will disappear as well. The excess of new-home buyers over new homes being built makes that inevitable. But the oversupply is so enormous that the healing process could take as much as three more years. Only then will prices in former bubble markets start rising again...

The New Affordability is now in place. But if rates rise, we'll have to establish a New New Affordability - at even lower prices.