Tuesday, April 20, 2004

Is Real Estate Defying Financial Gravity?

by Peter G. Miller

If you like good news it would be hard to outdo the release issued on Friday by the National Association of Home Builders.

"Housing starts increased to a seasonably adjusted annual rate of 2.007 million units in March, the Commerce Department reported today. The pace was 6.4 percent above February's upwardly revised rate of 1.887 million and 15.2 percent above the March 2003 pace."

Better than 15 percent in a year?

Let's have some perspective. Last year, 2003, was astonishingly good for both the national economy and the real estate industry.

  • Existing home sales reached 6.1 million units, a record and up 9.6 percent from the year before, according to the National Association of Realtors (NAR).
  • A typical existing-home cost $173,200 in December 2003, according to NAR. That was up 6.7 percent from a year earlier.
  • "Total new single-family home sales for 2003 reached 1.085 million, up 11.5 percent from the previous annual record of 973,000 in 2002," according to the National Association of Home Builders.

Is it reasonable for real estate sales and prices to keep rising, now that the economy seems to be in a rebound mood?

The answer is not especially clear. A growing economy is likely to be associated with rising interest rates, and interest rates have been the engine behind much real estate activity in recent years.

In the past few weeks, Freddie Mac says rates climbed from 5.52 percent to 5.89 percent, both with .6 points. The result, according to the Mortgage Bankers Association, is that loan applications dropped 22 percent in a week.

It's obvious that 5.89 percent is higher than 5.52 percent, but is this difference really enough to reduce mortgage applications by a fifth? This hardly seems warranted.

If you look at mortgage rates during the past 20 years or so it's tough to ignore the overwhelming pattern: Rates have more-or-less trended down over time, reason enough to finance with an adjustable-rate mortgage (ARM).

In 1984, for example, the slow-moving and consumer-friendly 11th District Cost of Funds rate reached 11.039 percent in August of that year versus the current 1.841. If you take the index, add a 2.5 percent margin, it means a borrower 20 years ago was paying 13.539 percent versus 4.341 percent today.

Given today's mortgage rates, it's hard to imagine that eight percent was once a bargain, seven percent was the find of a lifetime or that six percent was even feasible.

It may be that first-time and middle-age buyers and borrowers simply have no frame of reference other than the ever-falling rates seen in the past few years. To such folks, the "steep" rate rise seen earlier this month must seem somewhat scary, or at least contrary to the usual pattern.

But rates must eventually rise at some point. Will the real estate marketplace simply shut down when interest levels "zoom" to 6.5 percent or, shudder, 7 percent?

The answer is "no" and here's why: Even when rates have been ridiculously high homes have still sold -- and prices have risen.

In 1984, for example, typical home prices rose 3 percent and 2,829,000 existing units were sold according to the National Association of Realtors. Interest rates? In July and August of that year the prime rate hit 13 percent.

I suspect that when interest rates rise again it will be an evolutionary process rather than a quick jump of one or two percent. The result will be rate shock for those who do not remember the past -- or that real estate is a long-term investment.

There's little doubt that low interest rates inflate real estate sales. But beyond mortgage levels there are other reasons to buy homes -- the desire to live indoors, the potential for appreciation and the possibility of refinancing at low and better rates in the future.

Should rates begin to rise again watch successful investors in your community. Odds are that if the local population is growing, savvy investors will be in the marketplace -- buying. After all, it's tough to find homes today for $72,400 -- and that was a typical selling price in 1984.

For more articles by Peter G. Miller, please press here.

Published: April 20, 2004

Sunday, April 18, 2004

HOUSING BOOM: The Realtor thing

Hot real estate market has more trying to cash in as agents


From left, Joanna Calhoun, Debbie Smith and Nancy Mosco look over the lot map at Echo Canyon development in northwest Las Vegas.
Photo by Gary Thompson.

Debbie Smith said her commission for brokering a couple of good real estate transactions in Las Vegas can easily exceed what she earned as an elementary school teacher in Los Angeles.

Smith, a 30-year-old Realtor with American Realty, obtained her real estate license last year in California and heard a lot of talk about the lucrative market in Las Vegas.

That's what brought her here in July.

"It wasn't just about the money," she said. "It was a new challenge. There's the chance to get ahead. It seems like you come out here and everybody's in the business. Realtors, title companies ... everything revolves around real estate and development."

Real estate agents are multiplying at a faster rate than most jobs in Las Vegas, attracted by a housing market that continues to post record numbers in all categories and is being fueled by the lowest interest rates in 40 years and in-migration of about 7,000 people a month.

Local experts in the industry estimate there are at least 12,000 people with real estate licenses in the valley.

The Greater Las Vegas Association of Realtors, the largest professional trade group in Nevada, admitted its 10,000th member earlier this year, tripling in size since 1991.

But what initially looks like a gravy train can turn into an apparition for many newcomers to the business, one experienced Realtor warned.

Perhaps one-fourth of real estate agents make six figures a year, said Lee Barrett, president of the Greater Las Vegas Association of Realtors and a Century 21 broker.

Competition for a limited number of listings in the undersupplied Las Vegas housing market can leave the rest of them fighting like dogs for leftover scraps.

"A lot of people get into it with blinders on because they've heard how successful it can be," Barrett said. "It's a lot of work. Most people that do $100,000 are agents working 60-hour weeks. It depends on how hard you want to work to make the money."

Smith said she's constantly on the phone, working weekends and nights.

"But I was doing that in teaching, too," she said. "Obviously, the time is your own and you can put as much as you want into it."

Southern Nevada's population increased 82 percent from 1991 to 2002 and the number of licensed Realtors increased 138 percent during that period.

Las Vegas is not alone in experiencing a boom in real estate agents. Strong housing construction nationwide has led to a surge in newcomers, a National Association of Realtors survey showed.

New agents entering the real estate industry accounted for three-fourths of the national association's 102,000 new members last year, the survey showed.

David Lereah, chief economist for the national association, said membership growth "reflects the historic level of home sales while other sectors of the economy experienced weakness."

About 5 percent of national association members, or 48,000, have been in the profession for just one or two years. The average member has been in business for 13 years, with a median of eight years for sales agents and 17 years for brokers.

For the first time, a majority (52 percent) of real estate brokers are women.

The survey showed the typical member is a 51-year-old married woman with a gross personal income of $52,200 who works 40 hours a week and often communicates with clients by e-mail.

Agents are usually affiliated with an independently owned, nonfranchised firm, where they receive training and education.

They complete 13 transaction sides a year, representing either the buyer or seller, equivalent to 6.5 full sales transactions.

Half of all Realtors practice as both buyer agency and seller agency, with disclosed dual agency for in-company transactions; 73 percent of members are compensated by a percentage of commission split.

The gross personal income of sales agents rose 15 percent between 2000 and 2002 to a median of $39,300, while the gross income of brokers declined 11 percent to $65,300.

"The decline in broker income results from a rise in the number of less experienced brokers, a decline in the number of hours worked and an increase in the number of brokers whose primary function is sales," Lereah said.

Larry Murphy, president of SalesTraq, a local housing research firm, said agent commissions are being squeezed by home builders who have buyers lined up to purchase new subdivision phases before they're even built.

Instead of the standard 5 percent to 7 percent, agents are lucky to get 1 percent to 2 percent in many cases, he said.

Realtors also face competition from discount realty companies such as Help-U-Sell, where owners take a more active role in selling their house at a significant savings in fees.

The average broker fee for a Help-U-Sell transaction in Las Vegas is less than $3,000, company spokesman Mike Henle said.

"With houses selling as quickly as they are now, the consumer generally feels there's absolutely no reason to pay a typical realtor higher commissions when the house is going to sell about as fast as they get the signs up," he said.

Although Smith said Realtors get knocked for not having much of an education, the national association survey showed that 90 percent pursued education beyond high school, compared with 69 percent for the U.S. labor force as a whole.

Only 6 percent chose real estate as their first career; 15 percent worked in sales before entering the field.

Barrett, a Las Vegas native who's been in real estate for 26 years, said a lot of people used to get into real estate after they retired or turned 40 and wanted to make a career or lifestyle change.

"Now we're getting more people under 30, we're getting graduates with marketing degrees right out of college. We never had that before," he said.

Real estate agents are required to take 90 hours of education at a school accredited by the Nevada Real Estate Division.

After undergoing a background check, including fingerprinting, they affiliate with a broker and then apply for their license.

Not everyone with a real estate license is designated as a Realtor.

The Greater Las Vegas Association of Realtors, founded in 1947, provides education, training and political representation for its members, who must also abide by a strict code of ethics.

Many don't realize what the business entails, Barrett said.

"It's like running a hot dog stand. You've got to figure out the minimum number of hot dogs you need to sell, how much volume you need to achieve your goals," he said.

The Realtor profile showed 15 percent conduct some business in a language other than English, which also shows a higher level of ethnic diversity than the national association survey would suggest.

Four out of 5 Realtors frequently use e-mail for business purposes, 50 percent use a digital camera and 70 percent have a home office.

"There's been continued growth in the use of technology," Lereah said.

Total existing-home sales, which include single-family, apartment condominium and co-operative sales, rose in 47 states in the fourth quarter of 2003 compared with the same period in 2002, the national association reported.

Nationwide, the seasonally adjusted annual rate for existing-home sales was 7.2 million units in the fourth quarter, up 9.3 percent from the 6.59 million-unit level in the fourth quarter of 2002. The fourth-quarter 2003 mark was second only to a record sales pace of 7.39 million in the third quarter of 2003.

"Clearly, the historic lows we've seen in mortgage interest rates this year are the biggest factor in record home sales, but the growing number of households entering the prime years for buying a first home will be driving the housing market for years to come," Lereah said.

The strongest increase was in Wyoming, where the fourth-quarter resale pace rose 32.8 percent compared with a year earlier. Nevada existing-home sales rose 32.6 percent from a year earlier. Alaska posted the third-highest increase, up 24 percent. Three states showed minor declines.

Wednesday, April 14, 2004

House prices 'to fall 30pc by end of decade' - UK


The bubble is about to burst as property values rise to a level many prospective buyers cannot afford, claims a market expert. Becky Barrow reports

House prices could fall by 30 per cent over the next five years, according to Tony Dye, the fund manager known as "Dr Doom" for his accurate if heavily delayed prediction of stock market decline.

Mr Dye, who became prominent in the City through his consistently pessimistic approach to the equity market during the 1990s, said that recent house price growth would "all end in tears". "I have thought this for some time, but I think we really are probably somewhere near the end of it [the boom]," he said.

Tony Dye: 'herd instinct'

Mr Dye's comments will fuel concerns that Britain's housing market is a bubble that is waiting to burst as prices rise to levels that many cannot afford.

A buyer would now have to find more than £150,000 to buy the average home, which is about seven times the average salary in this country, according to the Halifax.

Mr Dye, who runs Dye Asset Management, an investment management group, said: "Everyone is hoping for a soft landing but no, we don't have soft landings in things like this, ever. The only way you could stop that is by government interference but this market is just too far gone for that."

Click to enlarge

Mr Dye, who partly blames the "herd instinct", joins a small but growing band of housing market sceptics who continue to predict a collapse despite the publication of endless surveys showing that prices are still rising.

Earlier this year, a report entitled "Bubble Trouble" was published by Durlacher, a small investment bank whose market capitalisation of £23 million means that it is worth less than some of London's most expensive properties.

Click to enlarge

The author, David Pannell, predicts a fall of up to 45 per cent, triggered by various factors such as weakness in the buy-to-let sector and mortgage companies being too generous with the amount that they are prepared to lend.

He said yesterday: "You need a psychologist not an economist to explain the housing market at the moment because it is illogical what is happening."

For home-owners who are worried by Mr Dye's comments, made during an interview with the Financial Times, they should remember his track record.

During the 1990s, when Mr Dye attracted the "Dr Doom" nickname, he was also called "the City's most famous pessimist" for his insistence that many shares were over-valued.

Mr Dye, who was chief investment officer of Phillips and Drew, stuck by this view at a time of a stock market boom when everybody seemed to be making money apart from his funds.

He left the company in March 2000, a moment that ironically signalled the decline that he had been predicting for several years. By the end of 2000, the FTSE index of Britain's 100 biggest public companies had fallen by 10 per cent. "I'm now less wrong than I was," Mr Dye said at the time.

Home-owners may be comforted by the fact that it took a long time for Mr Dye's prediction to be correct, and his pessimism proved to be an expensive mistake for several years.

In the housing market, anybody who had listened to other similarly pessimistic predictions over the last few years and decided to rent, not buy, would have missed out on a sharp rise in prices.

Optimists still far out-number pessimists in the housing market, with one saying yesterday that "crocuses were more likely to be found on Mars" than Mr Dye's prediction come true.

John Wriglesworth, the economist at Hometrack, the property research group, said that several bad things would have to happen for such a pessimistic forecast to come true.

A decision by the Government to increase the rate of stamp duty, sustained terrorist attacks and the Bank of England's monetary policy committee voting to double the base rate would be likely to cause a downturn.

Despite the doom-mongers, two housing experts - the Nationwide and Hometrack - have recently upgraded their annual forecasts as prices continue to rise at a rate which was not anticipated. Between January and March, prices rose by 6.2 per cent, according to the Halifax.

Prices in some parts of Wales, which used to be immune to price inflation, remaining one of the few affordable parts of the country, have risen by more than 50 per cent over the past 12 months.

Who Cares About the Housing Bubble?

Who Cares About the Housing Bubble?

Is it full speed ahead for the housing market, or are we headed for a crash? How exactly should you play this one? Dayana Yochim has a novel idea: Just don't.

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By Dayana Yochim (TMF School)

On your mark. Get set. Buy! (Or sell. Or build, borrow, or refinance.) And so the real estate market has gone in recent years. With record-low interest rates and record-high new home developments, the question on everyone's mind is: How exactly should you play this market?

The answer: Just don't.

Sure, the housing bubble may burst just days after you close on a new, pricey property. Or it might inflate and continue to strengthen, buoying an investment that your ancestors will celebrate for generations. Rates might skyrocket and housing prices may plummet. Toe-tapping and hand-wringing won't do you any good. If you buy a house (or choose not to) for the right reasons, it won't really matter.

House vs. home
I'm not intentionally glossing over the gravity of this issue. I know that two-thirds of Americans own their homes, and that for the majority, it's their biggest debt and accounts for the lion's share of their lifetime net worth. But a swig of Pepto and a small perspective shift are overdue.

There's a reason that your great-grandmother's needlepoint reads "Home Sweet Home" and not "House Sweet House." The difference between a house and a home is more than semantics.

It's the same reason why real estate agents ask sellers to stow away personal knickknacks during an open house. Family photos and homey touches make clients feel like intruders. Stripping them away makes it easier for prospective buyers to picture themselves making the house their home.

The Barbie Dream House (note that it's called a "house") was just a place for her to park her convertible and change outfits before her dream dates with Ken. Her furnishings were generic and the layout suggested a transient abode. It was more beachside timeshare than Vermont family estate.

A home, on the other hand, is where you lovingly hang great-granny's plaque and record your kids' growth spurts on the kitchen door jamb. It's where you build Saturday morning traditions, find the best hide-and-seek spots, burn the linoleum in your first attempt to make pancakes, and create the comfortable settings that fill your family's memories and photo albums.

I'll stop with the mush. Anyone who owns a home knows that it's not all sugarplums and wall-painting parties. According to Home magazine, homeowners should annually factor in 5% to 7% of their home's value to cover care and handling. (For those scrambling for a calculator, that's $12,500 to $17,500 per year on a $250,000 abode.)

And what about the home as massive piggy bank? Sure, houses historically appreciate in value. Someday yours might even provide a handsome windfall for you or your kin. But it's not an investment. Unless you own a home that you rent out for extra income, you shouldn't consider yourself a home investor.

On the other hand, approaching home ownership with some of the same level-headedness we advise in stock picking is not such a bad idea after all...

Why buy?
Have you been waiting in the wings for home prices to cool down, or perhaps you put in a few bids only to watch the ranch go to a buyer who could offer much more than list price? Maybe you even considered a counter-offer, even though it was well above what you promised yourself was your top price.

Buying a home, particularly in a hot geographical market, is an exercise in emotional restraint and lightning-fast high-dollar decisions. Sounds a little like the stock market, doesn't it?

It's not a bad idea to approach home buying with the attitude of a savvy stock investor. We've long preached the benefits of buy-and-hold investing. The same approach translates well to the home-buying market. First, use only money for your down payment that you do not need (for college, for cars, for cruise vacations) for at least the next five years. You can reduce price risk if you buy a home in which you plan to stay put for at least five years.

Next, do a real-life assessment of what you can really afford (and not what the bank claims you can). You've heard the term "house rich, cash poor," right? Trust me, you don't want it to be used to describe you. Consider a worst-case-scenario: How would you feel if your home's value tanked next year? What if you or a spouse were transferred to a new locale and you had to sell? The ability to answer such questions honestly will help you avoid the stink of market timing and speculation.

A lot of people avoid such considerations and instead base their decision to buy solely on the potential tax savings. Well, think again. Our own tax guru, Roy Lewis, implores readers to buy a home, not a deduction. "Tax savings shouldn't be among the biggest reasons to buy a house," he writes. "While the interest that you pay on your home mortgage likely will reduce your taxable income and your overall taxes, make sure that this deduction is really all it's cracked up to be."

He goes on to correct the old wives' tale upon which too many home buyers base buying decisions: "Many of you (far too many) still believe that if you pay $100 in home mortgage interest, you'll reduce your tax bite by that same amount. That's just not the case. Taxes are a percentage game. If you're in the 25% marginal tax bracket (as are the majority of taxpayers), then that $100 in mortgage interest paid actually reduces your tax liability by only $25... maybe."

Like investing, some considerations are quite personal. My colleague Mathew Emmert and I have considered the rent vs. buy issue, and our reasons for remaining renters are quite different. Mathew suffered housing sticker shock when he moved to the Washington, D.C., area and is still grappling with the rent vs. buy issue. I got a lot of flak from readers when I wrote about why I won't buy.

While some may see my desire to have a cushy emergency stash of cash as ludicrous, it does illustrate another very important investing principle: Your decisions should be guided not by the market but by your personal situation.

For those who own
It's not just buyers feeling lost in today's real estate market. Current homeowners can also benefit from the "do nothing" perspective shift. Again, long-term buyers will most likely be rewarded. What dashes the dreams of the long-term homeowner are short-term catastrophes that drain the bank accounts.

An adequate emergency fund can save you from having to sell at the exact wrong time. What about the ups and downs of home prices on your block? Remember, you don't lose a dime of your investment until you actually sell.

If you're considering taking out a home equity loan, make sure it's for the right reasons. Again, think long term. Using the extra cash to pay for essential expenses that improve your family's future is one thing (think home improvement, college). Borrowing the money for a short-term treat (e.g., vacation, car stereo) is quite the opposite.

Whatever history tells us about this time period, remember that a home is where you live. When you're tempted to somehow play the current market, just don't.

Monday, April 12, 2004

A bubble in housing, with worries of a pop

Some fear mortgage rates could cause major problems

By Martin Wolk
Updated: 4:09 p.m. ET April 12, 2004

The government’s report of a surge in hiring last month already has driven up mortgage interest rates, reviving speculation about a national housing bubble that could pop with devastating consequences. But try telling that to Joel Hawk, a real estate agent in San Diego, one of the nation’s hottest housing markets.

A 1,000-square-foot home Hawk recently listed in the city’s rapidly growing Mira Mesa community drew 12 offers on the first day, including 10 above the asking price of $375,000. The house sold for $391,000, he said. A similar home with a pool nearby sold in one day for the asking price of $425,000, he said.

“This market is just so heated -- it is just incredible,” Hawk said. “Buyers have to make decisions on the fly. In the past they had a couple of days to think things through. Today they are much more educated. … They go in with their eyes wide open, and they understand what the market is.”

To skeptics, this is exactly the sort of anecdote that justifies concerns about a home-buying mania comparable to the tech-stock bubble of the late 1990s. In this view, a mortgage rate increase of less than two percentage points could be enough to trigger a downturn in which home values could fall 15 to 20 percent -– far more in overheated coastal metro markets.

“The fact that there has been an unprecedented run-up in home prices over the last eight years creates the possibility for an unprecedented decline in the years ahead -- just as the spurt in the Nasdaq at the end of the ’90s created the basis for its plunge after March of 2000,” said Dean Baker, co-director of the Center for Economic and Policy Research, in an essay on the think tank’s Web site.

Low rates, little inventory
Baker and others have worried publicly for years about the emergence of a housing bubble, but an extraordinary period of low interest rates has allowed the market to defy gravity -– despite the loss of more than 2 million jobs over the past three years.

The median price for an existing home rose to $170,000 in 2003, up 15 percent from just two years earlier. Yet housing actually grew more affordable during that period as the typical mortgage rate fell to 5.74 percent from over 7 percent. The average monthly payment on a median-priced home was 17.8 percent of median family income in 2003, down from 18.4 percent in 2001, according to the National Association of Realtors.

“Right now the markets are working -- the fundamentals are very good in housing,” said David Lereah, chief economist for the Realtors.

He pointed out that nationally there is a little more than four months’ worth of housing inventory on the market, compared with more than nine months’ in 1989-90, the last time the market went bust.

With the economy once again creating jobs, even at a relatively slow pace, many industry experts and economists believe that a soft landing is the most likely scenario for the housing market as a whole. But as mortgage rates rise, nasty price declines could whipsaw some local markets.

“Our own sense is there will be a slowing of price appreciation but no widespread price corrections,” said Nicolas Retsinas, director of Harvard University’s Joint Center for Housing Studies. “Absent widespread job losses that would essentially force sales, the underlying fundamentals would argue for a sustainable rate of growth.”

Retsinas and others have been surprised that home prices have continued to rise at a steady clip through the recent recession and early stages of recovery. A government report issued last month startled many analysts, showing that home prices rose in the fourth quarter at an annualized rate of more than 14 percent, the biggest one-quarter jump in nearly 25 years.

“To me, that was a little bit of a concern,” said Doug Duncan, chief economist for the Mortgage Bankers Association.

For the full year, home prices rose 8 percent on average, with increases seen in all 220 metropolitan areas, ranging from 21 percent in Fresno, Calif., to about 1 percent in Austin, Texas, according to the federal House Price Index.

“I think there are some places where prices will fall,” said Duncan, who believes overheated coastal markets are the most vulnerable.

Other options for buyers
Even though the supply of homes is relatively scarce in many metropolitan areas in the Northeast and West Coast, the situation could turn around quickly if mortgage rates were to rise. The national apartment vacancy rate is at a record 10.2 percent, meaning many would-be home buyers would have plenty of attractive options if monthly mortgage payments were to become unaffordable.

Still, even if fundamental factors turn against the housing market, home prices rarely decline because homeowners are extremely reluctant to sell at a loss, Retsinas and other experts said. “You don’t day-trade housing,” Retsinas noted.

The more likely result is that sales would slow substantially, as happened in the early 1980s when long-term mortgage rates peaked at 18 percent. Although average home prices continued to rise – at least before adjusting for inflation – sales bottomed out at 2.4 million units in 1982, compared with a record 7.2 million last year.

A slowdown in sales would no doubt be damaging to the economy, affecting a wide range of industries from construction to financial services, but it would not be the same as a bubble deflating the biggest financial asset held by tens of millions of American families.

“People who follow the industry closely are watchful, but I don’t know that anyone is deeply concerned,” said Duncan.

Perhaps the biggest concern is that a sharp increase in delinquencies and foreclosures would force banks to take a harder look at potential buyers and clamp down on lending standards. A cover story in the current Washington Monthly magazine contends that banks have all but abandoned their responsibility to independently verify home values because they are able to eliminate any risk by quickly selling mortgages on the secondary market created by Fannie Mae and Freddie Mac.

“What is going to end this thing is rising interest rates and affordability issues and qualifying questions and concern on the part of banks,” said Ed Leamer, director of the UCLA Anderson Business Forecast.

He said the most likely trigger would be a sharp rise in interest rates caused by Chinese and Japanese investors pulling back from the market for Treasury securities to shore up their own currencies.

“It’s hard to see in 2004, but in 2005 I think there is a substantial risk we are going to have a nationwide macroeconomic problem precipitated by problems in the housing market,” Leamer said.

Needless to say, housing industry officials disagree.

Even after a quarter-point spike in interest rates since the strong employment report April 2, the average 30-year fixed-rate mortgage is still well under 6 percent -- virtually the same place it was a year ago.

David Seiders, chief economist for the National Association of Home Builders, predicts sales will drop only 2 percent this year from last year’s 7.2 million, which was a third straight record year.

“At the moment,” he said, “this feels like a pretty conservative place to be.”

The Sequel to the Stock Market Bubble:

Mark Weisbrot

As the stock market bubble ballooned to its pre-crash peak four years ago, those who held to the philosophy of "Don't Worry, Be Happy" put forth a variety of alternatives to the laws of arithmetic. Most of the journalists that I talked to told me that stocks were worth whatever people were willing to pay for them. It's a new economy, argued others: stocks are less risky, so they will be held at a lower return and therefore a higher price.

They were wrong, and although it wasn't that difficult to prove it, few bothered to try. My colleague Dean Baker was the first and practically the only economist in the country to do the requisite math. He showed that there were no believable projections for the growth of the economy or profits that would allow for the stock prices of the late 1990s to be sustained. Few paid attention -- although it is now fashionable to say, "yeah, everybody knew there was a bubble." But if everybody really did know there was a bubble, they would not have lost over $7 trillion dollars when the stock market crashed.

Now Baker has discovered another bubble, and more people are listening this time. The arithmetic of this bubble is even simpler than the last one: just look at what has happened to housing prices since 1995. Nationally, they have increased more than 35 percentage points beyond the overall rate of inflation. Is that unusual? You bet it is. If we look at housing prices from 1951-1995, they increased at the same rate of inflation. Then housing prices took off.

There is no plausible explanation for this sudden increase other than a bubble. Part of the bubble's expansion is explained by the enormous wealth of the stock market spilling over into real estate, as happened in Japan during the 1980s. Even after the stock market crashed in 2000-2002, financial "experts" -- the same ones who mistakenly counseled unfortunate 401 (k) investors that there was "no way" anyone investing in the stock market for the long run could lose -- recommended housing as the next big thing.

Of course, that is exactly what a bubble is -- people buy an asset because its price is rising, and that pulls more buyers into the market. Prices rise further, and the cycle continues, without regard to the real value of the asset -- whether it is stocks, housing or tulip bulbs in the 17th century.

But all bubbles must eventually burst, although it is very difficult to predict the timing. Our stock market bubble could conceivably have continued for years longer than it did. To see an example of what that would have looked like, consider Japan: in 1989 their Nikkei stock index hit a bubble peak at 39,000. Today, more than 14 years later, it is less than 12,000. Imagine the Dow dropping to less than a third of its peak value and still sitting there 14 years later.

Although the crash is hard to forecast, we do know that the longer a bubble persists and the bigger it grows, the more likely it is to burst sooner rather than later. In the case of the housing bubble, there are signs that it is getting close to breaking. One is the large divergence between the rise in rental prices versus home prices. This cannot persist for long, because people can choose whether to buy or rent.

Over the last year, housing prices increased by 8 percent while rental prices increased by only about 2 percent. In some of the bubble areas, such as Seattle and San Francisco, rents are actually falling. And rental vacancy rates are at a record high nationally. These are indications that the bubble's end is near.

A rise in long-term interest rates, which would push up mortgage interest rates, could collapse the housing bubble faster than anything else. Even after the recent jump in interest rates -- to 4.23 percent on the 10-year Treasury note -- long-term rates are still very low by historical standards. But inflation has been rising: the Consumer Price Index is up 3.7 percent at an annual rate over the past three months, as compared to 1.7 percent over the last year. And the dollar's decline portends more inflation in the near future, especially as the dollar remains quite overvalued (another bubble) -- as witness our current account deficit, which stands at more than 5 percent of GDP.

The Fed has been uncharacteristically indifferent to the prospects of increasing inflation. It has not only kept short-term rates at a 46-year low of 1.0 percent, but in its last statement the Fed said that the risk of "an unwelcome fall in inflation" now "appears almost equal to that of a rise in inflation." Alan Greenspan has also denied the existence of the housing bubble; it's hard to imagine that he really believes either of those two things.

More likely, Mr. Greenspan would probably like to postpone the inevitable bursting of the housing bubble. The Fed chairman did the same with the stock market bubble: after a brief comment about "irrational exuberance" at the end of 1996, he retreated and allowed the bubble to expand enormously, with the Dow growing by 80 percent and the NASDAQ nearly quadrupling before the crash.

This raises an important question: what is the responsibility of political leaders and policy-makers with regard to bubbles in asset markets? Mr. Greenspan could have prevented the stock market bubble from reaching its distended proportions, simply by explaining the basic arithmetic to the public. A number of political leaders from either party presumably could have done the same.

The collapse of the stock market bubble caused a recession in 2001, followed by a jobless recovery of unprecedented weakness in the labor market. We are still experiencing the fallout, including the aftermath of a corporate crime wave currently working its way through the courts. Millions lost much of their retirement savings; the government's latest household survey of employment reported last week showed that people over 55 accounted for an incredible 103 percent of jobs gained over the last year.

Economists at the International Monetary Fund -- which to its credit has been warning about our housing bubble for some time -- have estimated that its collapse could have as much as twice the negative impact on the U.S. economy as did the stock market crash in 2000-2002.

It makes no sense to remain in denial when so much is at stake. Even from the most libertarian, "free-market" approach to policy, there is a public interest in disseminating accurate information so that markets can function efficiently. Bubbles are not examples of markets operating efficiently -- in fact they are the opposite. And the bigger they grow, the harder they fall.

Are Low Interest Rates Causing a Bubble?


April 12, 2004 -- You've all seen the headlines: Housing prices are going through the roof.

Here in New York City, the prices are particularly insane.

The average sale price of an apartment in Manhattan topped $1 million last month, according to The Corcoran Group, a real estate brokerage firm.

Desperate buyers mob open houses, bidding wars are common, and properties routinely go for above the asking price.

Late last year, an open house for a 500-square-foot studio apartment (that means one room, folks) in the quiet Gramercy Park neighborhood drew nearly 30 people. The apartment got three bids and sold within a day for the $299,000 asking price -- in cold, hard cash, the New York Post reported.

And it's not just in New York. Boston and Washington, D.C. remain hot, too. Housing prices in the District of Columbia posted the nation's biggest five-year gain -- some 90%.

California is also on fire. More than 19,000 homes sold for $1 million or more in the Golden State in 2003, a new record, and the number of homes sold in Southern California hit a 15-year peak last month, according to DataQuick Information Systems.

Even in the San Francisco Bay Area, which is just shaking off the impact of the dot.com bust, home prices are heading skyward again. February's sales were the second strongest on record for the month, after February 2000, according to DataQuick. And you all remember what happened the month after that, don't you?

Which naturally brings us to the question du jour: Are we in a housing bubble?

Well, it sure looks like a bubble and feels like a bubble. We all -- especially those of us in the media -- have a natural tendency to believe that any display of such seemingly irrational exuberance is bound to end badly.

"I promise you, this housing hysteria will end in devastation for many families, and they have only their own 'house lust' to blame," one self-described renter wrote to the Los Angeles Times recently.

We've seen that argument before in newspapers, television programs and magazines.

These days, some observers fear that artificially low interest rates are letting marginal buyers flood the housing market and bid for houses they otherwise couldn't afford.

That's true, to some extent, but there are other forces at work that make this period very different from the late 1980s, when a wave of speculative building and buying sent the market reeling for years.

Here, I need to put in a very big disclaimer: My wife and I recently sold our apartment and bought another one in the mad Manhattan market. So, clearly, we have a vested interest in whether it really is different this time.

The way I see it, though, it all boils down to supply and demand.

On the demand side, affluent buyers in their 30s and 40s, armed with low monthly mortgage payments and plenty of cash, are hitting the market en masse and are determined to "get in the game," says Patricia W. Cliff, senior vice president at Corcoran in New York.

These are typically two-career couples who have good jobs, have saved their shekels, maybe have some family money and emerged relatively unscathed from the bear market.

"People have married later and they're having children later. These first- and second-time buyers have more capital, " says Cliff.

And if they work on Wall Street (as many here in New York do), they have fat bonuses burning a hole in their pockets following a blowout 2003.

If the stronger economy is emboldening people to buy, low mortgage rates are making even pricier properties affordable. Last week, 30-year fixed rate mortgages averaged 5.38% nationwide.

"Big increases in prices are not translating into big increases in monthly payments," says Dr. Raphael Bostic, who heads the Casden Real Estate Economics Forecast at the University of Southern California.

Dr. Bostic has found that homeowners' real monthly mortgage payments today (based on median price, adjusted for inflation) are actually lower than what they were in 1990, when rates on 30-year mortgages hovered around 10%.

He believes mortgage rates would have to go up "quite a bit" -- maybe two to three percentage points -- before we'd see a significant slowdown in the market.

But what sets this housing frenzy apart is a profound lack of inventory in certain markets.

By the end of 2003, there were only 6,000 or so apartments for sale in Manhattan, about half the number there were at the beginning of the year (see Chart).

And it's not only because properties are being snapped up faster.

First of all, some older Baby Boomers, now in their late 50s, have probably settled in to their final family homes and are unlikely to trade up.

"For a number of reasons they are staying put," says Cliff. "There isn't a lot of [upward mobility] in that age group."

Then, environmental laws, growth restrictions, rent control and the sheer lack of affordable land in the most desirable areas all have put a lid on new supply.

"Academic studies show where there is more restriction in building homes, there is more price appreciation," says Lawrence Yun, an economist with the National Association of Realtors.

In cities like Atlanta and Dallas, which don't have such limits, price appreciation tends to be more modest, he says.

"In the coastal areas where the land [has] been developed or restricted and the existing homeowner is not moving out, it's creating a housing crunch," he concludes.

And there you have it: a Perfect Storm of supply and demand.

Markets like this can't last forever, of course -- at least at this level of intensity.

But unless rates move up sharply (which, Dr. Bostic reminds us, would also signal a much stronger economy and could actually encourage more buying for a while) or we have some kind of economic crash, I don't really expect the kind of dramatic drop in real estate values we experienced in the early 1990s.

Demand will probably cool somewhat, but I just don't see where the new supply will come from.

Over the long term, of course, real estate is a great investment. Sure, it took about a decade for the average price of a Manhattan apartment to match its peak in 1988-1989, but it has surged ahead in the years since (see Chart).

And in the 30 years from the beginning of 1974 to the end of 2003, that average price advanced 1,479%, compared with a gain of 1,129% for the Dow Jones Industrial Average.

Of course, few people stay in their homes that long these days. But as we all know, you can't live in a stock, either.