The housing bubble? Glad you asked…

During the past year or so, it seemed no expert or news outlet could stay mum when the housing market came up in the national conversation. Here is a digest of the speculation from major media regarding the much-disputed bubble.

In the headlines…

“America’s House Party”
When people feel rich, they spend whether their wealth is actual or merely on paper. It’s called the wealth effect, and it’s even more potent with housing than with stocks. Over the past three years, the wealth effect from rising home values accounted for a third of all growth in consumer spending, which was single-handedly responsible for keeping us out of recession for two years.

Although real estate is less volatile than stocks, there are troubling aspects to the real estate boom. At the stock market’s peak, 1 percent of investors controlled about 33.5 percent of stock wealth; the top 1 percent of home-equity holders have only 13 percent of housing wealth. A broad drop in home values would affect a far larger cross section of Americans than did the NASDAQ bust. Complicating that danger, home buyers have turned to some risky strategies to afford their purchases. If enough homeowners become swamped by their debts and have to sell, prices would drop creating a reverse wealth effect and exacerbating a slowdown. Time, June 5, 2005, Cover Story

“Will the walls come falling down?”
A fall in American house prices could be bad news not just for American homeowners, but for the rest of the world. Robust American demand has supported export-driven growth in many economies, particularly emerging markets and Asia. If American consumers have to raise their abysmal savings rate, exporting nations will feel the pinch.

Most worryingly, a collapse in American export demand could trigger a vicious cycle. In order to keep their currencies low against the dollar, and thus boost exports to America, Asian central banks have been accumulating dollar reserves, which they have poured into Treasury bonds. This has increased the supply of capital in America, and thus been at least partly responsible for the borrowing binge that fuelled the housing boom. If house prices fall, and suddenly poorer Americans have to cut back on their purchases, this will shrink the supply of cheap credit from Asian central banks, pushing up interest rates and causing house prices to fall even further. The Economist, April 20, 2005, Cover Story

“Is the Housing Boom Over?”
Over long periods home prices are tethered to two fundamentals: local rents and household incomes. Today something unusual is happening even in this modest recovery, the rental market is extremely weak. The explanation is simple: The excitement around mining money from lots and shingles, coupled with the lure of low rates, is persuading people to buy houses even though rentals are, in many cases, a far better deal.

Since the mid-1990s, prices nationwide have risen an astounding 25 percent faster than rents. According to data from Fidelity National Financial, the ratio of house prices to rents now stands at 15.2, a 20-year high and a level that is simply unsustainable. As usual, the gap is most glaring in hot markets. In time, rents will exercise a gravitational pull on housing prices. Fortune, September 20, 2004, Cover Story
[Editor’s note: Rents in about 85 percent of major metro areas have climbed in the last year, according to recent reports, changing the situation somewhat.]

“That Sinking Feeling Is Your Apartment Like a Dot-Com Stock?”
The scariest aspect of today’s real estate market is the conviction that houses are always a good investment. According to Miller Samuel, the median price of a Manhattan co-op has tripled since 1995, vastly exceeding the performance of, say, the S& 500, which has merely doubled. But the median Manhattan co-op also cost the same in 1999 as it did in 1981, eighteen years earlier. Over that period the S& 500 rose tenfold (before dividends!). New York Magazine, May 23, 2005, Cover Story

“An Iron Bubble: Housing Market Isn’t Deflating”
Real estate in New York is unlike real estate in any other hot market: More than 80 percent of co-ops in the United States are located in New York, and co-op apartments make up about 80 percent of New York’s residential real-estate market. The tendency of co-op boards to weed out speculative investors suggests New Yorkers are primarily buying property for personal ownership rather than to turn a quick profit.

And a Business 360 study concluded that the price of housing still recovering from the early 1990s decline is indeed undervalued. The report predicts price increases of 10 percent per year through 2007, followed by a 5 to 8 percent annual gain through 2010 a slowdown, but only a decrease in the rate of increase. New York Observer, June 6, 2005, Front Page

From the experts…

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“That Hissing Sound”
Many bubble deniers point to average prices for the country as a whole, which look worrisome but not totally crazy.

But Princeton economist Paul Krugman notes that the national average blends results from metropolitan areas like Houston and Atlanta where it is easy to build houses and prices rose 26 and 29 percent, respectively with results from areas like New York, Miami and San Diego where population density and land-use restrictions make construction difficult and prices rose 77, 96 and 118 percent, respectively. In the latter areas, Krugman argues that it only makes sense to buy if you believe that prices will keep rising rapidly, generating big capital gains which is pretty much the definition of a bubble. The New York Times, August 8, 2005

“The Bubble’s New Home”
A price slide could begin at any time with the crescendo of “talk,” contends Yale economist Robert Shiller. He uses the word to cover everything from the recent Time magazine cover story on the vertiginous rise in home prices and the popularity of cable-television shows about rehabilitating and investing in real estate to the breathless newspaper stories of Miami condos being “flipped” for profit a half-dozen times before construction even begins. To Shiller, the housing bubble grew out of the same irrational exuberance that gave rise to the 1995-2000 stock mania. That would perhaps explain why most of the housing bubbles around the globe occurred in countries that also had stock bubbles.

Housing busts often start almost imperceptibly and unfold slowly. They’re difficult to detect in their early phases, in part because accurate price data on comparable-home sales is hard to come by. Homeowners often live in denial of market realities by listing their properties at unrealistic prices or simply taking their homes off the market to await better times. Shiller foresees a 20 to 25 percent cumulative decline in nominal prices (which works out to about an average of 2 percent a year over the decade). Barron’s, June 20, 2005

“Bubble Debate Moves From ‘If’ to ‘Where'”
Alan Greenspan recently described the U.S. housing market as a “collection of only loosely connected local markets” that have no direct pricing relationships and therefore harbor little national risk of a bubble. But what if the bubbles proliferate enough to make one big foamy mess?

The most overheated local housing areas in the U.S. 22 major metropolitan markets now account for 35 percent of the value of the country’s residential real estate, up from 24 percent in 1995. It’s such a large share of the total market that a sharp fall in their values could stall or slow national economic growth. The Wall Street Journal, June 20, 2005

From left field…

“Although a bubble in home prices for the nation as a whole does not appear likely,” Greenspan began in that obsessively measured tone of his…” There do appear to be, at a minimum, signs of froth in some local markets.”

Froth? What the heck is froth?… The largest single investment of most American families is now being compared to the top 2 inches of a Starbucks vanilla-almond latte? This is the solid economic foundation we’re supposed to build our futures on? Ellis Henican, Newsday, June 10, 2005

Maybe this is the most ominous sign of trouble ahead in the real estate market: The Kiwanians have gotten into condos.

When real estate investor Warren Hickernell became head of fundraising at the South Sarasota Kiwanis Club, he wanted to try something different. He told his brethren right from the start: “I don’t want to sell candy. I don’t want to sell little trinkets. Here’s what I do…” What he did was buy modest houses, fix them up, and sell them. The club agreed to put money into his deals. But a couple of years ago Hickernell stopped buying houses for the club. The problem? It was getting harder to find bargains. “Amateurs are running up the prices here,” he says. “People are asking too much.” So Hickernell came up with a new strategy. He found an old mom-and-pop motel and converted it to condos.

It sold out before the renovation was done, and now Hickernell and the Kiwanians are on their second motel. Fortune, September 8, 2004

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