REVIEW & OUTLOOK - A Housing Bubble?
online.wsj.com
For anyone handing out medals for our current economic recovery, the superhero has been housing.
Residential real estate has been so strong, in fact, that it is making more than a few smart people wonder if we aren't witnessing another "bubble," not unlike the one that hit the Nasdaq a couple of years ago. We have a healthy respect for the judgment of investors, but the question is worth looking at for its policy implications.
Housing has literally pulled the U.S. economy through a very dicey year. When manufacturing wimped out and the stock market began its dive, consumer spending didn't miss a beat. Many investors who pulled their cash from stocks have put it into the real estate market as a safer alternative. While several trillions have evaporated from stock valuations since the market top, the home equity market has appreciated by about half as much.
This appreciation of home values and the ability to monetize it through refinancing have allowed owners to pull cash from their home equity and spend it. Changes in housing finance and low mortgage rates have also made home owning more affordable for more people and kept the demand for houses growing. And with strong demand, of course, home values keep going up. In 2001, housing prices rose 5.7% after inflation. In April the average year-over-year price for a home was up nearly 9% -- the largest increase in more than a decade.
Optimists -- God bless 'em -- argue that this can all keep going for years and years because of a steady demand for housing fed by favorable demographics. The sages at Fannie Mae and the Federal Reserve cite immigration, which remains strong and seems to carry with it a desire to own a piece of the rock. This helps the market for first homes. There's also the boomer generation's appetite for trading up to McMansions and buying second or even third homes.
But now for the caveats, starting with the fact that prices are curiously high. Over the past couple of years housing prices have risen faster than incomes. To meet those prices, home buyers are resorting to greater levels of mortgage debt; down payments have been getting smaller and smaller, to the point that the average down payment by first-time buyers dropped to 3% in 1999 from 10% a decade earlier.
At the same time, mortgage payments are running as high as 42% of income -- way up from their normal range of 25% to 30%. The result: Housing payments are at the highest level as a share of disposable income since the Federal Reserve began tracking them, and are up 45% since 1980. The growth of mortgage debt has exceeded income growth over the past several years.
But the most troublesome sign is that credit standards are falling in an effort to keep people buying. An early sign of any bubble is when lenders start to use ploys they wouldn't dream of indulging in normal times. For example, mortgage lenders are now offering interest-only loans for up to 15 years before principle repayment starts, and they are permitting higher and higher loan-to-value contracts.
There's no doubt that some of this high-energy lending has been made possible by innovations in housing finance. Chief among them is the securitization of mortgages: Lenders who originate mortgage loans can spread their risk by selling loans to institutions, private banks and those government-sponsored institutions known as Fannie Mae and Freddie Mac, who, in turn, pool them and sell them to investors.
But securitization has also created dangers. The loan originators, who have incentive to value houses at the maximum possible, know that they are going to lay off the risk. So they tend to choose appraisers who are known to assess value on the, um, high side. And, as these columns have noted, Fannie and Freddie are themselves worthy of greater scrutiny, as they grow at rapid rates and in the process concentrate ever more of the nation's housing risk into two large, taxpayer supported entities (we won't call them "savings and loans").
Now, we aren't wearing our fright wigs yet. While housing prices are high and rising, perhaps the optimists are right. The Greenspan Fed, which once warned of "irrational exuberance" for stocks, has if anything tried to spur this housing boom via lower interest rates as a recession antidote. And so far it's worked.
But a characteristic of bubbles is that you only know you've been in one after it's popped. We're merely looking out over the horizon and offering the caution to the Fed and to regulators to keep an eye on their monetary policy and lending standards before today's housing boom does become a bubble.
Updated July 8, 2002 |
