Sales of existing houses rose in October to the highest level since February 2007 as first-time buyers raced to close deals before the scheduled end an $8,000 tax credit this month.

The National Association of Realtors says October sales rose 10.1% to a 6.1 million annual rate from 5.5 million in September. The median sales price fell 7.1% from October 2008, the smallest drop in more than a year.

Congress acted to extend the tax credit, but reduced the amount by $1,500. Under the new rules, people who have owned their current house for at least five years can claim a tax credit up to $6,500 to buy a house if the deal is completed by April 30, 2010.

Uncle Sam’s effort to goose sales raises a basic question: Do tax incentives strengthen the long-term outlook for the housing market or simply create a short burst of activity that masks continuing weakness?

The US Bureau of Labor Statistics says the nation’s unemployment rate last month rose to 10.2%, the highest in 26 years. Some analysts say the unemployment rate may remain above 10% for the first half of 2010. A weak economy and uncertain employment prospects almost certainly will cool the housing market when the incentives expire.

The Mortgage Bankers Association says delinquencies continue climb and a record 14% of homeowners were behind on mortgage payments or in foreclosure in September. The hardest hit states are Arizona, California, Florida, and Nevada which together accounted for 43% of new foreclosures.

A research report by Wells Fargo Bank says the record-high $1.4 trillion federal deficit now totals about 10% of Gross Domestic Product and could slow future economic growth.

“The stock of debt held by the public, as a percentage of Gross Domestic Product has never been as high during peacetime -- the current high was last surpassed during the aftermath of World War II,” Wells Fargo chief economist John Silvia and economic analyst Kim Whelan wrote. “Wartime spikes in debt levels were temporary, however, and therefore didn’t permanently damage economic growth prospects. In contrast, the current path of indebtedness shows a permanent venture into economically unfavorable territory.”

Higher spending and lower tax revenue during the recession combined to create the current deficit. An economic rebound will boost revenue but increased entitlement spending, especially money spent on entitlement programs for an aging population, will likely drive deficits higher. This raises questions about the sustainability of current spending, especially if the health-care bill about to be debated in the Senate becomes law.

Analysts say:
 

The concern is twofold, both the outsized and the perceived long-term nature of the deficit are problematic. Were it only one of these and not both simultaneously, the apprehension would be considerably diminished. While the budget gap will narrow in the near term as emergency spending slows during the economic recovery, the long-term trend does not show a return to fiscal discipline, rather the destruction of it. The prevention of such an outcome lies in the hands of both policymakers and the electorate.

In the short-term, the housing market improved. The National Association of Realtors says the number of previously unsold houses fell 3.7% in October to 3.6 million, a seven-month inventory at the current sales pace. That’s the lowest supply of existing houses for sale since February 2007.

Sales of existing single-family houses increased 9.7% to an annual rate of 5.3 million while sales of condos and co-ops rose 13.2% to an annual rate of 770,000.

By region, sales increased 11.6% in the Northeast, 14.4% in the Midwest, 12.7% in the South and 1.6% in the West.

The US Commerce Department will report new home sales on November 25. Analysts look for an increase to an annual rate of 451,000 houses in the fourth quarter from 391,000 a year ago and 434,000 in the third quarter.

Homebuilders’ stock rose in mid-day trading Monday. Hovnanian Enterprises (HOV) rose 1.72%, D.R. Horton (DHI) rose 1.74%, Lennar (LEN) rose 1.24%, and Pulte Home (PHM) rose 1.27%. Also read Four Reasons to 'Punt' Toll Brothers.

Figures released Monday by the National Association of Realtors are good news, but as long as unemployment, federal spending, and the debt remain high, renditions of “Happy Times Are Here Again” are premature.