Countrywide Financial (NYSE: CFC) CEO Angelo Mozillo, who spooked the stock market when he delayed his forecast for a housing market recovery until 2009, has been one of the most realistic executives in the housing industry. However, his downbeat assessment still may be overly optimistic.

If housing prices were inflated by a credit bubble as some have indicated, it will not be easily resolved. Indeed, data released today from the National Association of Realtors shows the pace of existing home sales fell to a four-and-a-half year low while new mortgage applications hit their lowest level since February.

Under one scenario, if there is a major shock to the credit markets and the economy, the number of defaults could skyrocket. Home prices could recover in 2009 but from a much lower level. This is what occurred in the Great Depression. However, people usually don't abandon their homes if they can avoid it. With unemployment rates at near record lows and Fed Chairman Ben Bernanke keenly aware of the situation and ready to react, I don't think this scenario is likely.

The other scenario involves a slow re-adjustment back to the long-term averages. Home prices may drop minimally on annual basis for the next five to ten years until we return to reality. People will find that in ten years their home will be worth approximately what they paid today. The home will be a dead asset as opposed to an investment vehicle for long-term appreciation.

Some predict that either scenario will be devastating to the stock market. The first scenario would definitely fit this prediction. However, the second more likely scenario may not. In the late 1980's and early 1990's, we experienced a similar problem with Savings and Loans related to junk bonds. However, the problem acted as overhang to long-term economic growth but did not usher in a secular bear market. There were brief but terrifying downturns in 1987, 1990, and 1994. However, the market continued to rise.

With this announcement the housing market moves one step closer to painful reality. However, do not extend this analysis further than is warranted by the facts and data.

Doug Roberts is the Founder and Chief Investment Strategist for FollowtheFed.com, an independent research firm focusing on investment strategies using the Federal Reserve's impact on the stock prices.