Friday, December 24, 2004

If Home Prices Plunge, Will Damage Be Worst in Democratic States?

By FLOYD NORRIS , The New York Times

NO boom lasts forever, and in countries like Britain and Australia, the housing market has suddenly turned lower, leading to discussions of how a plunge can be avoided and what will happen if it is not.

The American housing market received a scare yesterday, with a report that the pace of new-home sales slipped in November as the median price of a new home fell to the lowest level in a year. But mortgage applications indicate that a rebound has begun, and in any case, prices of new homes can fail to capture price trends for existing homes in areas without new construction.

A more reliable measure, albeit one that is reported more slowly, is an index that compares prices over time on the same house and is put together by the Office of Federal Housing Enterprise Oversight, which regulates Fannie Mae and Freddie Mac. Even though the index excludes many higher-priced homes, and thus probably understates house price inflation, it is booming like never before.

Through the third quarter, it showed prices up 13 percent over the previous 12 months. The index, which dates to 1980, had never before recorded even a 10 percent annual gain. In the last five years, the index shows a gain of 48.5 percent, while consumer prices for things other than housing have risen 11.8 percent. The absolute gain and the spread over inflation are records. The only time that was even close was the period through 1989, which was followed by a housing bust in 1990 that caused prices to plunge in some areas.

If this is a bubble, its creation can be traced in no small part to the Federal Reserve's efforts to deal with the bursting of the stock market bubble. It cut rates aggressively and the 2001 recession was a mild one. The very low cost of borrowing, coming at a time when alternative investments seemed less desirable, encouraged a big run in home prices, whose growth outstripped both personal income and rental prices.

There are indications that speculation is rising. Patrick Lawler, the chief economist of the agency that compiles the index, reports that the popularity of interest-only and adjustable rate mortgages is rising. That would indicate more and more buyers are straining to qualify for loans - and would be vulnerable if interest rates rose.

The housing market would not have to collapse to have a negative impact on the economy. Even a lack of appreciation could put a damper on consumer spending by depressing sentiment and the volume of refinancings.

House prices vary significantly by market, of course, and it is reasonable to think that a decline in prices would be most likely in areas that have had the strongest gains. And those areas are concentrated in states that voted Democratic in the last election. Of the 12 states with the fastest-rising home prices in the last four years, only Nevada and Florida voted for President Bush. The 12 states with the smallest gains all backed Mr. Bush.

Over all, states that supported Senator John Kerry averaged a 47 percent rise, while prices in Bush states climbed 24 percent. Rhode Island and California led the list of states, although neither could match the 80 percent rise in the District of Columbia. In California, the median-price home costs $460,000, and the state association of Realtors says only 19 percent of the state's residents earn enough to afford to buy such a home.

With the trade deficit hitting records, the American government seems to welcome a weak dollar. But there are surely limits to that. A nightmare for the Fed would be that it finds itself under pressure to raise rates to support the dollar, just at the time that a weakening housing market needs lower rates to avoid big declines. If that were to happen, the Fed might regret having done so much to encourage the boom in home prices.


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