Friday, December 24, 2004

Is U.S. house-price boom at a risky point?

Off the Charts, The International Herald Tribune
The great housing boom of the early 21st century is looking shaky. Governments are growing nervous about whether prices will hold, and what will happen if they do not.

Prices have begun to fall in Australia and Britain, and economists are asking if central banks can prevent a plunge. On Thursday, even the United States reported a fall in sales in November, although data on new mortgage applications indicate that a rebound has already begun.

The U.S. government also reported that the median sales price of new homes fell to the lowest point in a year, but such statistics tend to be volatile because prices vary widely by market. In any case, new home prices may not reflect trends in more desirable areas where no land is available for new construction.

A more reliable measure, albeit one that is reported more slowly, is an index put together by the Office of Federal Housing Enterprise Oversight, which regulates Fannie Mae and Freddie Mac, the large mortgage lenders. That index compares prices over time on the same house and uses them for an index. That does not completely capture improvements - the new kitchen or swimming pool - but it does deal with what are supposed to be the three most important things in real estate: location, location, location.

To be sure, the index ignores higher-priced homes, since it only gets reports on homes on which so-called qualifying mortgages, with a current maximum of around $333,000, are issued. But that means it probably understates the real price gains.

The latest report for that index, covering the third quarter, has renewed cries that there is a bubble in American house prices. Nationwide, it showed prices up 13 percent over the previous 12 months. The index, which dates back to 1980, had never before recorded even a 10 percent annual gain.

That gain comes after the market had been very strong for many years. Over the past five years, the index shows a gain of 48.5 percent, while consumer prices for things other than housing have risen only 11.8 percent. The gain itself and the spread above the inflation rate are both records. The only other time that even came close was the period through 1989, which was followed by a housing bust in 1990, in which there were substantial declines in some previously overheated markets.

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 interest rates aggressively and repeatedly, and the damage to the economy was held to a mild recession. The resulting low cost of borrowing, coming when alternative investments seemed less desirable, encouraged a big run in home prices, the growth of which 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 that more and more buyers are straining to qualify for loans and would be vulnerable if interest rates did rise significantly.

Rising home prices make homeowners feel richer, and home-equity loans let them spend that wealth. But they also make it harder for those not in the market to afford homes. In California, where home prices have risen rapidly, the state association of real estate agents calculates that only 19 percent of the people make enough money to be able to afford the median-priced home, which costs $460,000.

The housing market would not have to collapse to have a negative impact on the economy. Even a lack of further appreciation could put a damper on consumer spending, both by depressing sentiment and by reducing the money available from refinancings.

House prices vary sharply by market, and a decline in prices may be most likely in areas that have seen the strongest gains. And those areas, as it happens, are almost all in states that voted Democratic in the last presidential election. Of the 12 states with the fastest-rising home prices over the past four years, only Nevada and Florida voted for President George W. Bush in the election. Over all, states that supported Senator John Kerry averaged a 47 percent rise, while states that went for Bush saw prices climb 24 percent. Rhode Island and California led the list of states, although neither could match the 80 percent rise shown by the District of Columbia.

With the trade deficit hitting new records, the American government seems to welcome a weaker dollar. But there are surely limits to that. A nightmare for the Fed would be that it finds itself under pressure to raise interest rates to support the dollar just as 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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