Tuesday, August 24, 2004

Sales of Existing Homes Took a Breather in July

By A WALL STREET JOURNAL STAFF REPORTER

From The Wall Street Journal Online

Aug. 24, 2004 -- NEW YORK -- Sales of existing homes declined in July, as the resilient U.S. housing market appeared to pause for a breather as mortgage rates remained relatively low.

The National Association of Realtors said Tuesday that existing-homes sales fell 2.9% to a seasonally adjusted annual rate of 6.72 million units last month, from a downwardly revised 6.92 million unit pace in June. June resales had previously been reported at a 6.95 million annual rate, a 2.1% rise from May's record level.

"There are those that talk about price bubbles and I continue to tell you there are no price bubbles," said NAR Chief Economist David Lereah. "Prices are surging, particularly in the West, where they rose 17%. We have a supply problem ... inventories have been depleted." The group now expects U.S. sales will top 6.4 million in 2004.

The July report failed to meet Wall Street expectations. However, Mr. Lereah said July's numbers were the third best annualized rate of home resales ever and the first drop since January. Analysts had expected existing-home sales to decline 2.2% to a 6.95 million rate.

[existing-home sales]

Mortgage rates rose sharply in May and June, but have settled well below 6.0% in recent weeks to an average of 5.81% last week, according to a survey compiled by Freddie Mac. The average interest rate for a 30-year fixed-rate mortgage hovered around 6.0% for most of July, compared to an average of 6.29% in June and 6.27% in May.

"There is no reason yet to expect any further significant decline in activity; with mortgage rates back below 6% … there is little chance the housing market will weaken in the near-term," wrote Ian Shepherdson, of consulting firm High Frequency Economics, in a note to clients. "Supply is still tight too, so prices will keep rising, though perhaps at a slower rate."

In July, the inventory of existing homes on the market remained stable at 4.3 months, slightly up from a revised 4.2 months in June, the NAR said. The median home price rose to $191,300 in July, compared with a revised $191,000 in June. The average home price edged up to $244,700 from a revised average of $244,500 in June.

Sales of existing homes were down in all regions except the South, where they rose 0.4%. Home resales fell 1.4% in the Northeast, 4.8% in the Midwest, and 6.6% in the West.

Data on new-home sales will be released Wednesday by the Commerce Department. Economists surveyed by Dow Jones Newswires and CNBC expect a 2.3% decrease.

Separately, Redbook Research's latest indicator of national retail sales shows sales down 1% in the first three weeks of August, compared with the same period in July. The report also shows seasonally adjusted sales in the month-to-date period up 1.9% from the same period in 2003. On an unadjusted basis, sales were up 1%.

The weaker tone for sales was attributed by Redbook to Hurricane Charley and the fact that "some retailers also believe that a later Labor Day holiday may be delaying back-to-school activity."

Redbook also noted "Given the large weighting of the discount stores in our model, it was this under-performance that was primarily responsible for the week's poor showing overall."

Discount giants Wal-Mart and Target have both projected weaker sales for August, with Wal-Mart revising its forecast on Monday to say it expected sales in stores open at least a year to be flat to 2% higher. An earlier company forecast had called for sales growth of 2% to 4%.

Friday, August 20, 2004

Bay Area home sales, prices decline in July

Experts say dip might portend a cooler market
Kelly Zito, Chronicle Staff Writer

Click to View

Bay Area home prices and sales last month throttled back from their record-setting pace in June, signaling what could be the start of a cooling trend in the local housing market, according to some experts.

The median price for a home in the nine Bay Area counties in July was $514,000, down 0.4 percent from July's median of $516,000.

On a month-to-month basis, sales declined 8.8 percent, with a total of 12, 862 houses and condos changing hands last month, compared with 14,104 in June, a study by DataQuick of La Jolla (San Diego County) found.

While sales and price declines between June and July are common, DataQuick researcher John Karevoll said, the housing market might be heading into a lull.

Along with feeling the effects of weaker-than-expected job growth and declining consumer confidence, demand may be weakening because low interest rates this spring accelerated sales activity, leaving fewer buyers in the summer months.

DataQuick's reports, based on filings with county recorders' offices, reflect sales initiated 30 to 60 days earlier.

"The pool of buyers may have been tapped significantly by those circumstances, which means prices may start to level off and sales might come down a bit," Karevoll said, noting that the typical sales decrease between June and July is 5.5 percent.

Given that home prices have risen faster than incomes, it is not surprising the frenzy is dying down, UC Berkeley economist Ken Rosen said.

"We've had so much exuberance in the last 18 months, it's natural to see some decline," Rosen said in an interview.

Nevertheless, July's sales count was the second-highest on record behind June, and the median price represented a nearly 16 percent rise from the median of $444,000 a year ago. The median is the midpoint; half of sales were above and half were below.

Only three counties saw a decline in sales from July 2003, and that was limited to sales of existing, single-family homes. In Marin, Napa and San Mateo counties, those home sales dropped 2 percent, 4 percent and 7 percent respectively, DataQuick said.

In San Francisco, single-family home sales jumped almost 19 percent to 447.

In the short term, Rosen said, prices probably won't tumble, in part because the recent lackluster economic indicators won't play out in the housing market for a while. In addition, interest rates remain near historic lows.

This week, the average rate for a fixed, 30-year mortgage dipped for the third week in a row, dropping to 5.81 percent, said mortgage giant Freddie Mac.

By the end of next year, however, Rosen expects the long-term mortgage rate to hit 7.75 percent. Even if rates rise more modestly and job and income growth remains anemic, he and other economists say home prices could stagnate or decline.

"If the job gains don't materialize, it's harder than before to imagine that prices don't take a hit," said Michael Dardia, vice president at the Sphere Institute, an economic think tank in Burlingame.

Some industry insiders welcome a downshift in the market.

"We look at this as good news because the increase in the last couple of years has created a really tough situation, especially for first-time home buyers," said Leslie Appleton-Young, economist for the California Association of Realtors in Los Angeles.

In retrospect, 2004 will be viewed as a turning point when the market moved from frenzied to robust, she added.

By the trade group's measure, only about 14 percent of Bay Area households could afford the median-priced home in June, down from 19 percent one year ago.

The typical monthly mortgage payment in July was $2,361, compared with the peak $2,450 in June and $1,953 one year ago, DataQuick found.

A shift in the market might mean that more sellers have to rethink their asking prices, Appleton-Young said.

That prospect doesn't concern people like Bette Noll, a retired reading specialist in the Mount Diablo school district who lives in Walnut Creek. Noll, 65, plans to sell her four-bedroom Eichler home, which has a pool on one- third of an acre, within the next year.

She estimates that she'll be able to sell it for between $600,000 and $700,000 -- a good price in an area with excellent schools.

Noll said she is shocked at the asking prices for tiny, rundown homes in areas with subpar schools.

"I think there needs to be a reality check in the market," she said.


Bay Area home sales

While the number of Bay Area homes sold in July dropped from their record monthly high in June, this chart shows that sales remain strong.


Homes sold Median price
County July 2003 July 2004 Change July 2003 July 2004 Change
Alameda 2,354 2,804 19.1% $417,000 $499,000 19.7%
Contra Costa 2,334 2,544 9 394,000 450,000 14.2
Marin 471 482 2.3 661,000 726,000 9.8
Napa 196 209 6.6 427,000 505,000 18.3
San Francisco 656 806 22.9 543,000 650,000 19.7
San Mateo 1,015 986 -2.9 559,000 646,000 15.6
Santa Clara 2,690 3,056 13.6 475,000 537,000 13.1
Solano 903 1,016 12.5 308,000 370,000 20.1
Sonoma 882 959 8.7 386,000 459,000 18.9
BAY AREA 11,501 12,862 11.8 444,000 514,000 15.8.
Source: DataQuick Information Systems

Tuesday, August 17, 2004

Cement shortage hits US housing boom


Construction demands in China are one factor crimping global cement supplies and affecting 29 US states.

By Daniel B. Wood | Staff writer of The Christian Science Monitor

LOS ANGELES - Somewhere in China today, a dam is being built and it's ruining Bill Feltz's day.

"It's hurting us, no question," says Mr. Feltz, vice president of production for Anderson Concrete, a leading Central Ohio concrete firm. "The Chinese are building dams and roads and Olympic venues, so they are using more cement than they make." The extra demand is driving up the prices for the rest of the world, he says, so "here in Columbus, Ohio, a significant portion of that is coming out of our pockets."

Feltz says his company's profits may drop more than 10 to 15 percent this year, even though they try to pass extra costs - as much as 25 percent - to their customers. So far, he hasn't had to turn any customers away. From Connecticut to Florida, Texas to Michigan, and across the Southwest, shortages have become so severe that construction is being halted or slowed, leaving a growing number of roads, stadiums, and patios unfinished. The countrywide shortage of cement - the crushed limestone, calcium, and silicon powder used to bind concrete - could leave a significant pothole in the US economy.

"It's a very big deal," says Ryan Puckett, spokesman for the Portland Cement Association (PCA), a trade group that represents cement companies in the United States and Canada. The US has long imported about 25 percent of its cement, he says, much of which comes from China. With major Chinese construction projects moving ahead - from rural dams to urban skyscrapers - a fourth of the world's population is now using far more than it exports.

The worldwide shortage began to be felt across Asia first, then hit the shores of Florida last year. Since the US construction season began last spring, shortages have been declared in 29 states. Even though 114 US-based mills are running at 100 percent capacity seven days a week, they aren't keeping pace with demand. For companies who use the cement to mix the concrete they sell to customers, that means scheduling problems, layoffs, fewer profits, and concerns about the future.

"It's impacting customers, employees, company profits, and building projects all over the US," says Puckett. Delays and canceled projects are reported from retirement condo projects in Florida to housing developments in Phoenix to casino building in Las Vegas. "Everywhere there is construction, there are cement customers lined up without enough supply to keep them happy," he says.

The limited number of barges and shipping lines to bring the imported cement to US shores is adding to the problem. The demand for rebuilding in Iraq, and building projects from Hong Kong to Singapore, have significantly diverted supply ships to those countries. The supplies that are making it to US ports have been bottlenecked by transportation woes, observers say.

"One of the major issues [we] have faced this year is significant delays with the Union Pacific's system," says Lance Latham, spokesman for Ash Grove Cement Company, the fifth-largest cement manufacturer in the US, which recently announced plans to build a $250 million plant about 40 miles north of Las Vegas. "With one half of the world cement supply tied up in China, it's been difficult for the California producers to supply southern Nevada. [Union Pacific] Railroad didn't anticipate the economic growth occurring across the country and was caught shorthanded."

Mr. Latham and others say the current shortage is exposing both the shipping and US production limitations as problems that need to be addressed by public policymakers before the US economy is more deeply affected. The building of the Ash Grove plant will help alleviate a 23-million-ton gap between domestic production and consumption, but it won't be online until 2007 or 2008. The PCA estimates that a total of only 15 million tons of extra US capacity has been planned before 2010.

Some construction companies have already planned for shortages until 2005. Although raw materials needed for cement are not in short supply, both the cost and the regulations surrounding the construction of new mills to mix the cement are significant hurdles, observers say.

"The permitting process can take years because of regulations and the fact that many communities don't want a mill in their backyard," says Anderson's Feltz.

To help alleviate the problem, some contracting and homebuilding associations are pressuring the federal government to temporarily lift a ban on cement imported from Mexico. Such tariffs - now at 40 percent but recently as high as 80 percent - began 14 years ago amid US accusations that Mexico was unfairly competing with US companies by selling below cost.

Until demand abroad abates, shipping improves, or America ramps up production to alleviate dependency on foreign sources, continued shortages here are expected to sock smaller consumers and slow the US housing market - both by delays and higher prices. Completion time for a home in some key markets has increased about two months (now eight to 10 months) as cement prices have jumped home costs by $5,000 to $7,000.

"What is problematic is the unknown," says Feltz. "We make a long-term contract with someone for a given price and then, unforeseen by us, our cement prices go up. That leaves us taking the hit."

Monday, August 09, 2004

The Real Estate Bubble

Fred Foldvary
by Fred E. Foldvary

A soap bubble is a ball made of a thin film of soap dissolved in water. Soap bubbles are ephemeral, lasting a short time before bursting. There are also bubbles in the economy, classes of assets whose prices inflate like air in an expanding balloon and then collapse.

The expansion of asset-price bubbles is unsustainable, as the prices rise above what is warranted by normal returns and demands. The asset prices crash. A recent bubble was the technology boom of the late 1990s, when Internet and other stocks rose to levels that could not be justified from the likely profits of the firms.

The most important bubble in the economy is that of real estate. There has been a real estate cycle with a duration of 18 years since the early 1800s. Real estate booms have often become a bubble. It happened during the 1920s in the US, especially in Florida. It happened in Japan during the 1980s. And it is happening again now in the US.

The last bottom of the real estate cycle in the US was in 1990, when there was a recession. Real estate prices have been rising since then, and were not at all deterred by the downturn of 2001. Real estate speculation has carried real estate prices in some parts of the US, such as California, to heights that cannot be sustained when interest rates rise as the Federal Reserve reverses its low-interest policy. Another crash is coming.

Henry George, the American economist and social reformer of the latter 1800s, originated one of the first theories of business cycles. The basic cause, he said, was land speculation. During an economic boom, at first, a growing demand for real estate is met by reducing vacancies. But then new real estate is constructed, and rent and land values rise. Speculators notice this and buy land expecting to sell at higher prices later. This speculative demand, added to the demand for use, carries land prices so high that investments in enterprise become unprofitable. Land becomes priced for expected future uses, rather than present-day uses.

The fall in new investments then reduces demands for labor and goods, which then reduces other demands, and the whole economy falls into a recession and then a depression. Faced with rising vacancies, real estate prices collapse, bankruptcies rise, loans default, banks fail, and then the cycle begins anew. This theory of the business cycle was original with George and not part of the previous classical school thought. Georgist theory, which I coined as 'geoclassical' for emphasizing land, was a major advance in classical thought.

Even though a third of investment is related to real estate, the real estate cycle is ignored in neoclassical business-cycle theory. Mainstream economic doctrine tells us that unexpected shocks create the fluctuations in the economy. But the regularity of the major business cycle cannot be explained by random shocks. Neoclassical economic fails to explain the trade cycle.

The Austrian school of economic thought has its own theory of the business cycle, which does pay attention to real estate. In the Austrian theory, an injection of money into the banking system artificially reduces interest rates, as indeed has been happening in the US in recent years with the Fed increasing the money supply by 25 percent since 2001. With rates so low, borrowing for long-term slow-maturing investments - such as real estate construction and purchase - becomes profitable.

The money expansion is unsustainable; monetary inflation causes price inflation. As prices and interest rates rise, many of these projects become unprofitable. Austrian economists call them 'malinvestments,' investments that looked promising when interest rates and other prices were lower, but are not profitable when the price distortion caused by the money expansion reverses. The reduction and abandonment of investment projects leads to a depression.

The Austrian and the Georgist explanations are complementary. The Austrian half emphasizes the role of money and interest rates, and the geoclassical half emphasizes the importance of land and the role of land speculation. A geo-Austrian synthesis creates a powerful business-cycle theory that is consistent with history and goes a long way in explaining major business cycles.

The article 'This Inflated House' by Mark Thornton in the August 2004 Free Market journal, published by the Ludwig von Mises Institute, illustrates the Austrian-school attention to real estate. Thornton notes the widespread practice of extracting equity from real estate as owners have refinanced at lower interest rates. As recognized by the Austrian school, monetary inflation often does not at first lead to rising prices in consumer goods. The injection of money often first goes into investments, commodities, and land purchases.

As Thornton explains, 'the cause of higher home prices is that the Federal Reserve has kept interest rates, and thus mortgage rates, at historically low rates so that people find it easier to finance homes.' Real estate is bought mostly with borrowed money, and lower interest rates keep the financing cost, the monthly payments, low, even as real estate prices rise. Banking practices contribute to the bubble as they make interest-only loans with no money down. Lending standards typically relax as the bubble approaches its peak.

But the collateral of land value is an illusion. Land has no cost of production, and its price can fall to zero. But why should the banker worry? The bank deposits are insured by the federal government! If the bank fails, the government will bail out the depositors. This encourages more risky loans, which provide temporary profits and perhaps more stock options and bonuses for the banking executives.

Also, home loans can be sold in the secondary market facilitated by agencies which were established by the federal government. As Thornton tells it, 'The Federal Reserve and the Mac-May family (Freddie, Fannie, Sallie, etc.) have conspired to create a housing bubble in the US.' It's not a secret conspiracy but simply all these agencies breathing together to blow up the housing balloon that eventually has to burst.

Thornton says that it 'is difficult to predict how long bubbles will last,' but the geoclassical half of the geo-Austrian theory does provide an indication. Historically, the real-estate cycle has had a duration of 18 years, aside from the interruption of World War II. That puts the next real estate bottom around 2008. If past patterns continue, and so far they are right on schedule, we can expect the next recession to take place towards the end of this decade. With all the distortions caused by monetary policy and real-estate speculation and lax bank lending, the recession could be a major crash and the worst depression since the 1930s, an 'economic nightmare,' as Thornton calls it. And that nightmare does not even take into account the threat of terrorist attacks or the effects of continuing war and a possible oil crisis.

What is clear is that the tragedy and madness of the business cycle is not a natural outcome of a nonexistent free market, but caused by foolish government policy. Two remedies are essential: free banking and the public collection of land rent. Free-market banking would eliminate the monopolization of money and manipulation of interest rates by central banks such as the Federal Reserve, and leave money expansion to a competitive market of private banks. The elimination of taxes on income, sales, and produced wealth, replaced by tapping land rent for public revenue, would take the profit out of market-hampering land speculation fueled by tax-funded public works along with monetary inflation. Both reforms are necessary in order to completely eliminate the business cycle and the agony of business failures and idled workers.

But both reforms are ignored and disparaged by mainstream economics, so they are not enacted or even talked about. At least those who understand geo-Austrian theory will be warned in advance and can arrange their affairs to minimize the losses that others will suffer from.

Global Home Prices: A Big Chill As Housing Cools?

Business Week
Central bankers in Australia, Britain, and the U.S. have voiced concerns about rising home prices. Economists from Goldman, Sachs & Co. have now determined how overvalued those prices are. But a drop in home values in those markets could help the global economy.

Real home prices in the three nations were undervalued in the mid-1990s but then soared -- thanks to better fundamentals, such as demographics, rising incomes, low real and nominal interest rates, and the health of the nations' economies. The boost to consumers' wealth helped to lift demand.

The Goldman report calculates current home prices in the U.S., Britain, and Australia are overvalued by 10%, 15%, and 29%, respectively. A key reason for the runup was that, as mortgage rates fell, buyers could bid up prices without seeing any significant uptick in their monthly payments.

A Global Jump In Home PricesNow rates are rising, and history shows home prices adjust downward -- often by too much, cutting into consumer demand. If long rates rise one percentage point and prices overshoot, the Goldman paper says the drag on U.S. spending would be 2.4%, British demand would slow 1.9%, and Aussie purchases could slip by 3.1%.

On the plus side, notes the study, softer demand would help to rebalance the global economy away from excessive consumer spending, especially in the U.S. But there is a risk that demand could weaken too much at a time when some policymakers may not be able to offset the drag. The U.S. has little ammo left from fiscal or monetary policy. Britain could cut interest rates, but its fiscal budget is in the red. Only Australia has great flexibility because it enjoys an almost-balanced budget and nearly neutral monetary policy.

Bear in mind that soaring home prices are no longer an Anglo trend. The study notes Spain, France, Italy, the Netherlands, and Ireland have all seen big gains in home prices. Even in Japan, where real estate collapsed in the 1990s, prices have stabilized.

Clearly, though, the U.S., Britain, or Australia will first face the challenge of allowing home prices to adjust without disrupting the overall economy. Their successes -- or failures -- will offer guidance for other policymakers around the globe.


By James C. Cooper & Kathleen Madigan

The Real Estate Bubble

Fred Foldvary
by Fred E. Foldvary, Senior Editor

A soap bubble is a ball made of a thin film of soap dissolved in water. Soap bubbles are ephemeral, lasting a short time before bursting. There are also bubbles in the economy, classes of assets whose prices inflate like air in an expanding balloon and then collapse.

The expansion of asset-price bubbles is unsustainable, as the prices rise above what is warranted by normal returns and demands. The asset prices crash. A recent bubble was the technology boom of the late 1990s, when Internet and other stocks rose to levels that could not be justified from the likely profits of the firms.

The most important bubble in the economy is that of real estate. There has been a real estate cycle with a duration of 18 years since the early 1800s. Real estate booms have often become a bubble. It happened during the 1920s in the US, especially in Florida. It happened in Japan during the 1980s. And it is happening again now in the US.

The last bottom of the real estate cycle in the US was in 1990, when there was a recession. Real estate prices have been rising since then, and were not at all deterred by the downturn of 2001. Real estate speculation has carried real estate prices in some parts of the US, such as California, to heights that cannot be sustained when interest rates rise as the Federal Reserve reverses its low-interest policy. Another crash is coming.

Henry George, the American economist and social reformer of the latter 1800s, originated one of the first theories of business cycles. The basic cause, he said, was land speculation. During an economic boom, at first, a growing demand for real estate is met by reducing vacancies. But then new real estate is constructed, and rent and land values rise. Speculators notice this and buy land expecting to sell at higher prices later. This speculative demand, added to the demand for use, carries land prices so high that investments in enterprise become unprofitable. Land becomes priced for expected future uses, rather than present-day uses.

The fall in new investments then reduces demands for labor and goods, which then reduces other demands, and the whole economy falls into a recession and then a depression. Faced with rising vacancies, real estate prices collapse, bankruptcies rise, loans default, banks fail, and then the cycle begins anew. This theory of the business cycle was original with George and not part of the previous classical school thought. Georgist theory, which I coined as 'geoclassical' for emphasizing land, was a major advance in classical thought.

Even though a third of investment is related to real estate, the real estate cycle is ignored in neoclassical business-cycle theory. Mainstream economic doctrine tells us that unexpected shocks create the fluctuations in the economy. But the regularity of the major business cycle cannot be explained by random shocks. Neoclassical economic fails to explain the trade cycle.

The Austrian school of economic thought has its own theory of the business cycle, which does pay attention to real estate. In the Austrian theory, an injection of money into the banking system artificially reduces interest rates, as indeed has been happening in the US in recent years with the Fed increasing the money supply by 25 percent since 2001. With rates so low, borrowing for long-term slow-maturing investments - such as real estate construction and purchase - becomes profitable.

The money expansion is unsustainable; monetary inflation causes price inflation. As prices and interest rates rise, many of these projects become unprofitable. Austrian economists call them 'malinvestments,' investments that looked promising when interest rates and other prices were lower, but are not profitable when the price distortion caused by the money expansion reverses. The reduction and abandonment of investment projects leads to a depression.

The Austrian and the Georgist explanations are complementary. The Austrian half emphasizes the role of money and interest rates, and the geoclassical half emphasizes the importance of land and the role of land speculation. A geo-Austrian synthesis creates a powerful business-cycle theory that is consistent with history and goes a long way in explaining major business cycles.

The article 'This Inflated House' by Mark Thornton in the August 2004 Free Market journal, published by the Ludwig von Mises Institute, illustrates the Austrian-school attention to real estate. Thornton notes the widespread practice of extracting equity from real estate as owners have refinanced at lower interest rates. As recognized by the Austrian school, monetary inflation often does not at first lead to rising prices in consumer goods. The injection of money often first goes into investments, commodities, and land purchases.

As Thornton explains, 'the cause of higher home prices is that the Federal Reserve has kept interest rates, and thus mortgage rates, at historically low rates so that people find it easier to finance homes.' Real estate is bought mostly with borrowed money, and lower interest rates keep the financing cost, the monthly payments, low, even as real estate prices rise. Banking practices contribute to the bubble as they make interest-only loans with no money down. Lending standards typically relax as the bubble approaches its peak.

But the collateral of land value is an illusion. Land has no cost of production, and its price can fall to zero. But why should the banker worry? The bank deposits are insured by the federal government! If the bank fails, the government will bail out the depositors. This encourages more risky loans, which provide temporary profits and perhaps more stock options and bonuses for the banking executives.

Also, home loans can be sold in the secondary market facilitated by agencies which were established by the federal government. As Thornton tells it, 'The Federal Reserve and the Mac-May family (Freddie, Fannie, Sallie, etc.) have conspired to create a housing bubble in the US.' It's not a secret conspiracy but simply all these agencies breathing together to blow up the housing balloon that eventually has to burst.

Thornton says that it 'is difficult to predict how long bubbles will last,' but the geoclassical half of the geo-Austrian theory does provide an indication. Historically, the real-estate cycle has had a duration of 18 years, aside from the interruption of World War II. That puts the next real estate bottom around 2008. If past patterns continue, and so far they are right on schedule, we can expect the next recession to take place towards the end of this decade. With all the distortions caused by monetary policy and real-estate speculation and lax bank lending, the recession could be a major crash and the worst depression since the 1930s, an 'economic nightmare,' as Thornton calls it. And that nightmare does not even take into account the threat of terrorist attacks or the effects of continuing war and a possible oil crisis.

What is clear is that the tragedy and madness of the business cycle is not a natural outcome of a nonexistent free market, but caused by foolish government policy. Two remedies are essential: free banking and the public collection of land rent. Free-market banking would eliminate the monopolization of money and manipulation of interest rates by central banks such as the Federal Reserve, and leave money expansion to a competitive market of private banks. The elimination of taxes on income, sales, and produced wealth, replaced by tapping land rent for public revenue, would take the profit out of market-hampering land speculation fueled by tax-funded public works along with monetary inflation. Both reforms are necessary in order to completely eliminate the business cycle and the agony of business failures and idled workers.

But both reforms are ignored and disparaged by mainstream economics, so they are not enacted or even talked about. At least those who understand geo-Austrian theory will be warned in advance and can arrange their affairs to minimize the losses that others will suffer from.

Monday, August 02, 2004

Trouble Bubble... Or Not?

08/01/2004

There's a debate raging among U.S. economists as to whether the rapid run-up in housing prices in many markets across the country constitutes an investment bubble that could soon burst, with long-range repercussions on builders' ability to sell new homes at prices that cover costs and allow for an adequate profit margin. Here's a capsule look at both sides.

Pro-bubble: HSBC Securities economist Ian Morris recently published a 47-page analysis, "The U.S. Housing Bubble: The case for a home-brewed hangover," that argues expectations of future house price appreciation now are "spectacularly and unrealistically high," a reflection of the longest and strongest real house price boom in more than five decades. "Perceived risk of buying a house has dropped to all-time lows," Morris writes, "despite leverage at all-time highs."

House prices relative to income, rent, replacement cost and home equity have set new records, Morris writes. "Twenty states that account for half the population look shaky...all the more risky given housing supply has surged, with the vacancy rate at its highest in over 40 years."

U.S. house prices are "bubbly," Morris contends: "Prices are 10 percent to 20 percent too high and can overshoot on the way down...If the Fed is in tightening mode, the day of reckoning tends to come sooner. We think the party stops by mid-2005."

Anti-bubble: A recent report, "Are Home Prices the Next Bubble?" by Jonathan McCarthy, senior economist, and Richard Peach, vice president, of the Federal Reserve Bank of New York, concludes there's no imminent danger of a collapse in housing prices that would harm the U.S. economy.

They find "very little evidence" of a national home price bubble. "Rather," writes McCarthy, "it appears home prices have risen in line with increases in personal income and declines in nominal interest rates. Moreover, expectations of rapid price appreciation do not appear to be a major factor behind the strong hot market." The report is available online at www.newyorkfed.org/research/epr/forthcoming/mccarthy.html.

Counterpoint: However, says economist Raymond Sabat of EconomicBriefing.com, the two Federal Reserve economists made "a glaring error" by failing to "consider past declining interest rates as a cause of the bubble." McCarthy and Peach ignore "the structural components of the current housing finance market that will make any price decline even worse,'" Sabat writes. His analysis is online at www.economicbriefing.com/sabat/fedbubble.html.

Our take: Watch the number of pure investors (real estate speculators) in your market. Speculation creates artificial demand that can drive pricing bubbles. Housing markets are local, not national. Some markets may be bubbly. But it's hard to see prices falling precipitously across the country as long as job creation and underlying demand remain strong.

Sunday, August 01, 2004

Is It a Bubble If It Never Pops?

Business Week



The enduring strength of the housing market is confounding the conventional wisdom and may keep doing so for quite a while

So much for the housing bubble. As overheated as the real estate market may seem in certain parts of the country, it has thus far defied expectations of slowing down on a national level, let alone popping like a balloon. Most measures of housing activity -- from average sale prices to existing home sales to new residential construction -- are at or near record levels, even as mortgage rates have ticked up.

In June some housing data, along with a slew of other indicators, showed signs of slowing. But the Aug. 17 report on July housing starts pretty much dispensed with concern for the time being. They jumped 8.3% in the month, more than making up for June's 7.7% drop, according to the Commerce Dept. Residential units are being constructed at an annual pace that remains near a 2 million clip, just a slight dip from the record 2.067 million annual rate of December, 2003.

"It is now clear that the June drop in starts was an aberration," concludes research firm ActionEconomics. Mike Englund, its chief economist, now expects July figures on new and existing home sales, due out later in August, to be strong as well.

"FAVORABLE FACTORS." Despite a flattening in prices at the highest levels in the past year, the median home price has also kept climbing. On July 26 the National Association of Realtors (NAR) reported that the median sale price of a single-family home rose to a record $191,800 in June, 10% higher than the prior year. And on Aug. 9 the NAR upped its forecast for 2004 home sales to a record 6.45 million, up from 6.1 million in 2003.

"The bottom line is that mortgage interest rates have been lower than expected, the economy is improving, and jobs are being created in an environment of strong housing demand -- all favorable factors for record home sales," said NAR Chief Economist David Lereah in the release.

Earlier in the year the expectation was that mortgage rates would rise sharply in 2004, but that hasn't been the case. Even though 30-year loans are likely to average about 6.1% in 2004, up from 5.8% in 2003, that's still very low by historical standards. And home buyers who can't afford those rates have been able to jump into adjustable mortgages. Some housing experts believe rates would have to rise above 8% for the housing market to stumble.

RENTAL WARNING. On the supply side, homes available for sale nationwide remain at a record low inventory of just 4.1 months, according to the NAR. "Until the supply goes up, the increase in price is rational," says Prakash Dheeriya, a finance professor at California State University at Dominguez Hills, who's studying the Southern California real estate market.

Many bubble theorists worry that a flood of new homes will come up for sale at the first sign of weakness in home prices, crushing the market. But Dheeriya says his research shows prices won't drop suddenly even if mortgage rates climb, primarily because sellers who were trying to get out at the top of the market have already done so. "I don't think there can be a sudden onslaught of supply," he says.

That doesn't mean the housing market couldn't slow from here -- or that prices can't fall in some select areas. Dean Baker, co-director of the Center for Economic & Policy Research, points to a glut in rental housing, especially in some overheated markets like Seattle and San Francisco. If rental rates remain flat or decline while prices for comparable homes continue to rise, that will take the air out of the housing market.

"Eventually people will start saying that it's foolish to buy a home when you could rent instead," he says. He also thinks mortgage rates will rise in the next year to levels that will preclude many families from trading up to a bigger home.

GRADUAL COOLING? Mike Sklarz, chief valuation officer at Fidelity National Information Solutions, which provides real estate pricing tools to lenders, already sees some subtle signs of slowing -- such as a leveling off in home prices above $500,000 in many markets. He's hearing a lot more anecodotes of "for sale" signs going up in pricey neighborhoods, signaling that not enough affluent buyers may be available for all the high-end homes being built. "Overall, however, inventories are still at incredibly low levels, and this is not the kind of thing that can turn on a dime," says Sklarz.

The best hope of many economists is that the housing market will gradually cool down, preventing too many mini-bubbles from building up in overheated real estate markets around the country. In that sense, a few years of slower home-price appreciation would be welcome. But with supplies tight, and plenty of buyers able to afford homes, that's not even beginning to happen yet.