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What If Housing Takes a Double-Dip?

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NEW YORK ( TheStreet) -- Housing turned the corner in 2012, but what if around the corner there is a giant cliff?

The consensus view is that the market has bottomed and that home prices will continue to rise in 2013. But most positive forecasts rest on assumptions that could easily be upset.

Everyone agrees that all bets are off if Washington fails to reach a deal over a long-term fix to the federal deficit, triggering an automatic expiration of tax breaks and mandatory spending cuts in 2013- a concern commonly referred to as the "fiscal cliff."

Economists fear that if politicians "go over the cliff", the economy will fall back into a recession. It would be the "opposite of the stimulus", says Jed Kolko, chief economist at Trulia.

"The stimulus in 2009 pumped $800 billion into the economy over a few years. The fiscal cliff could take $600 billion out of the economy in one year," said Kolko. "If nothing in the fiscal cliff is resolved, if we do have big tax hikes and spending cuts persisting through next year that will hurt the economy and the housing market."

Kolko expects the fiscal cliff will be resolved, but other external shocks also remain.

A disorderly break-up of the Eurozone for instance could trigger a credit crunch once again that could see interest rates and unemployment rise.

According to Paul Diggle at Capital Economics, every 0.25% rise in interest rates reduces home price inflation by 1% to 2%. Meanwhile, "as unemployment rises, the mortgage delinquency rate would also increase and banks would be forced to dispose of a growing shadow inventory at a quicker pace. The inventory of homes for sale would increase sharply," says Diggle. "In these circumstances, the housing recovery would falter. Our model suggests that house prices could easily fall by 5% per annum over the next few years."

This is of course a bear-case scenario. Diggle's actual forecast is for a 5% rise in 2013 and a 4% rise in 2014. But the bear-case is not improbable.

Even if we set aside broad, macro concerns, there are still some reasons to be cautious about the housing recovery.

Housing demand in 2012 has been mostly from institutional investors who have seized the opportunity to buy distressed homes at deep discounts and convert them into rentals. While plenty of money is still sitting on the sidelines,that money can disappear if investors determine that the opportunity is no longer attractive.

Hedge Fund Och Ziff Capital (OZM) recently pulled out of the REO(bank-owned foreclosed homes) to rental business .

Institutional investors "may help drive home price appreciation in the short run, but are not likely to do so in the long run," Quinn Eddins, head of research at Radar Logic, a real estate analytics firm, wrote in a recent note."As prices for REO increase, the expected future appreciation must also increase in order for investors to achieve the same return on investment. If prices rise to a point where investors' expectations of future home price appreciation do not support their desired returns, then demand for REO will decline and prices could fall again."