Sunday, January 23, 2005

Investors could create a 'bubble'

John Stark, The Bellingham Herald

Home prices were shooting up in a lot of places last year.

Nationwide, the U.S. Office of Federal Housing Enterprise Oversight pegged the price-growth rate at 13 percent in the third quarter of 2004, the last period with available numbers. For California the rate was 27 percent, helping to drive the Pacific states' housing price increase rate to about 23 percent.

That has some economists warning that housing prices could be experiencing what they call a "bubble," a market phenomenon in which buyers bid up the price of a commodity simply because they expect the price to keep rising. When the psychology changes, bubbles burst. Think dot.com stocks.

John Calverley, chief economist at American Express Bank, recently published a book entitled "Bubbles and How to Survive them," subtitled "First Stocks. Now House Prices."

Interviewed by phone from his London office, Calverley stressed that he doesn't expect the price of the family bungalow to go the way of a share of Pets.com or E-Toys. But he also urged economic policymakers to be aware of the potential risk of too sharp a housing price rise that could lead to a significant slump, which could eliminate homes as a source of equity and crush consumer confidence, leading to a severe recession.

Calverley believes he sees signs of bubble behavior in the hottest U.S. housing markets, possibly even in Whatcom County, although that bubble is likely in its early phase.

"The pace of (price) rises and the enthusiasm for housing suggests ... that the U.S. is in the early to middle stages of a housing bubble, perhaps equivalent to where tech stocks were in 1997-8," Calverley said. "I expect prices to keep rising and increasingly get out of line with people's incomes. ... I think too many people are buying with the belief that house prices will always rise in the long term, which is not true, not in a low consumer price inflation environment."

He cited one key danger sign: investors buying rental houses or apartment buildings at prices higher than prevailing rents in the marketplace will justify. Some local real-estate agents say that is beginning to happen in Whatcom County.

"That definitely sounds like bubble behavior," Calverley said.

But he also doesn't think a big drop in house prices is in the near future here or in most other U.S. housing markets. Prices here and elsewhere could continue to rise for years before a significant downturn, he said.

Closer to home, two Western Washington University economists said they don't embrace the housing bubble theories of Calverley and others.

Economics professor Dan Hagen said the nationwide run-up in home prices is a natural consequence of record low rates for mortgages. If those rates finally begin to creep up this year, as many expect, the market will cool but not collapse, he said.

But Hagen also sees some danger that interest rates may have to go up sharply to keep foreign investment money coming into the United States, financing our twin deficits in federal spending and balance of trade. That could trigger the kind of scenario that Calverley is warning about.

"A lot of these things can work out if we have a robust recovery," Hagen said.

Hart Hodges, director of Western's Center for Business and Economic Research, thinks prices of local homes are justified by economic fundamentals such as a good local economy spurring demand for housing here, along with low interest rates. He pointed to historic home price data showing local housing prices rising in stair-step fashion, with sharp upswings followed by longer periods of stable prices or even modest declines.

But if prices continue their dizzying pace, he may start to worry.

"We aren't looking at something that's not sustainable," he said. "Another year like 2003 and 2004, and that changes. ... The more appreciation we see in 2005, the longer the flat spot we'll see in the future. There may be room for a little more. I don't think a little more is 10 percent."

But Lylene Johnson, a real-estate agent at The Muljat Group's Fairhaven office, thinks local prices may still have a long way to go. She thinks another double-digit increase is likely in 2005, even if prices don't match 2004's torrid upward pace. She doesn't see prices dropping or even leveling off here anytime soon.

"The reason I don't is because there isn't that much opportunity for additional development," she said. "Any time you have restrictions on development, you're going to have higher prices."