What If Housing Crashed?
Stephane Fitch and Brandon Copple, Forbes Magazine, 09.03.01
It's bad enough that the stock market's wealth effect is
disappearing. What happens to the economy if that other prop,
home equity, starts to wobble? There are ominous signs this is
about to happen.
If you need proof of the housing boom, just walk out onto your
driveway. Pick up the newspaper and read about how this vibrant
sector is propping up an otherwise teetering economy. Carpenters are
busy. Home equity lending is supporting a lot of consumption. Those
For Sale signs your neighbors are putting up could be just big
spenders wanting to cash in on the wild appreciation homeowners
have enjoyed in the past six years--40% in Atlanta, 54% in New York
City, 68% in Boston, 71% in Denver and 100% in San Francisco,
says research firm Case Shiller Weiss in Cambridge, Mass.
The general assumption seems to be: Stock prices fluctuate, but
house prices just go straight up. Could this assumption be wrong? If it
is, a large part of the economy is in danger. A burst of the housing
bubble wouldn't just hurt homeowners and people who own shares of
Fannie Mae or Toll Brothers. It could end up squeezing all Americans.
A real estate slump "could make this little recession we're having turn
into something that's quite drawn out and serious," says Yale
economist Robert Shiller.
Shiller--famed for his astute calling of the Nasdaq stock bubble in his
2000 book, Irrational Exuberance, but a long-time scholar of the real
estate markets--believes consumer confidence could take a bigger hit
from a real estate crash than from the stock market correction. It was
the boom in housing, he argues, more than the Nasdaq's 175% runup
in the 18 months leading up to March 2000, that made consumers
feel so flush and spend so freely. Go back as far as 1975 and
compare ebbs and flows in retail spending in all 50 U.S. states and 15
foreign countries, and it is clear housing markets directly affect
consumer spending, while stock market fluctuations don't, he says.
No one is talking bust--not yet, anyway. In fact, if you ignore what's
happening at the high end of the market and look only at midpriced
homes, you may be hard pressed to discern any kind of downturn,
especially in places like New York, Denver or Minneapolis, where
values are still rising. They've been going up for so long that many
people can't even recall the last housing recession of 1990-93.
Look closely, though, and you'll see the cracks starting to form. Sales
of existing homes nationwide in June were near the record pace set in
March. But sales of $1-million-plus homes, which outpaced all other
categories last year, sank 15% in the first five months of 2001. Supply
is beginning to outstrip demand. The U.S. inventory of unsold homes,
which fell steadily during the 1990s and reached a low of 1.4 million
homes last year, has spiked upward for the first time in a decade,
rising 23% since January, according to the National Realtors
Association.
Perhaps more tellingly, in muscular markets like Atlanta, Seattle,
Chicago and Washington, the pace of home sales is down 10% or
more. And it's taking a whole lot longer to find a buyer. John Hall has
been trying to sell his $370,000 downtown Chicago loft since April. He
left a good paying job on May 1 to try his hand at independent
consulting. He doesn't want the $2,700 monthly mortgage and tax
payments to suck his savings dry. He's had some tempting inquiries,
but no contract yet.
Shiller worries about an ominous mix of overdevelopment, inflated
home prices and rising consumer debt. Add two other factors that
historically have presaged a big drop in home prices--the plunge in
stocks and massive layoffs, (see chart)--and the case for a crash gets
stronger. It won't happen right away. It takes a while for people to let
go of optimism--not to mention an emotional attachment to their
home--and embrace economic reality. "They're in denial until they
take a direct hit," says Barton Smith, an economist at the University
of Houston.
The most visible sign of deterioration is in Silicon Valley. Santa Clara
County, Calif. has four months of inventory for sale, triple the levels
carried in the past three years, according to Creekside Realty in San
Jose. The market has been in the dumps since the beginning of the
year. Elizabeth and Alan Fletcher first considered putting their home
in Palo Alto up for sale in February, when houses like it had been
selling for $2 million--quite a jump from the $856,000 they paid in
1998. They hoped to reap a nice downpayment on a new
5,000-square-foot place they were building in the foothills above Los
Altos for $3.85 million.
But by the time they listed the house on April Fool's Day, an
economic earthquake had hit Silicon Valley. High-tech companies
were shedding tens of thousands of jobs, and shares of Oracle, where
Alan was a vice president, had dropped from $33 to $15 in just three
months. The Fletchers' real estate agent warned them not to list their
house for more than $1.4 million. Even at that price, the house sat for
more than a month without drawing a single offer. They lowered the
price by $100,000, then knocked off another $200,000. A buyer
offered $1 million; but then backed out. In late June they finally sold
their home for $1.04 million--down almost $1 million in just five
months. By then they had lost $250,000 in the stock market and had
to borrow $2 million for the new house.
This sort of weakness is expected in Silicon Valley, land of a million
scorched dreams. But what about other parts of the country? Just
north of Chicago, where prices have risen 24% since 1998, the tony
suburb of Lake Forest is suffering a housing correction. Douglas
Yeaman, chief executive of Prudential Preferred Properties, has 145
homes for sale priced at more than $1 million--13 months of inventory,
up threefold in two years. William Lederer, founder of Art.com, has
had his $7 million, 13-bedroom red-brick mansion listed since
January. No deal yet. |
