Housing's Strength Raises Another Bubble Concern
by Erin Schulte, The Wall Street Journal Online, March 30, 2002
The Federal Reserve's spate of interest-rate cuts last year worked for the housing sector like Willy Wonka's fizzy lifting drink did for Charlie Bucket, hoisting it into the stratosphere as homeowners rushed to refinance.
Now that the central bank is moving toward reversing that trend, however, analysts are debating whether housing is a bubble ready to burst, or simply a strong sector of the economy that will float gently back to earth.
"I'm increasingly hearing people talking about housing being in a bubble," said Steve East, managing director of economic policy and research for Friedman, Billings, Ramsey Group. "If the Fed is concerned, they want to be careful not to pop that bubble, and the quickest way to pop housing prices is to raise mortgage rates."
That's already happening. Mortgage rates, which rise and fall along with the federal-funds rate, have already started to come off the rock-bottom levels seen last fall. Rates for 30-year mortgages dropped to a three-decade low of 6.45% in November, but have since moved up to 7.14%, according to Freddie Mac's weekly mortgage-rate survey.
Given the economy's still-fragile recovery, the housing sector's strength is being closely tracked. Should housing somehow start to become a drag on the economy, the recovery could stumble, putting pressure on the stock market.
The recent rise in rates has already had an impact on the housing market. The Commerce Department said last week that the median price of a new home fell 2.4% in February from the month earlier to $179,600, though that was still 6% higher than a year earlier. On a year-over-year basis, new-home sales fell 6% in February.
And the National Association of Realtors said last week that sales of existing homes fell 2.8% in February to an annual rate of 5.88 million, coming off an all-time high in January. Month-to-month, median prices of existing homes dropped slightly, but they remained about 8.2% higher than the year earlier.
Another important piece of housing data strategists look at to determine demand is the supply level -- which is increasing.
"Inventories are backing up a little bit. There are a lot of little signs that [the housing sector] is starting to crumble," said Alexander Paris, president of Chicago-based Barrington Research Associates.
The Commerce Department said last week that the inventory of homes on the market slipped to a 4.3 months of supply in February from a revised 4.5 months supply in January; however, that was up from 3.7 months in December.
A report released Thursday from the FDIC said parts of the U.S. that saw robust residential building and rising housing prices during the economic downturn -- like San Francisco -- could be in bigger trouble than areas where building activity was more subdued.
In high-priced areas, homeowners had to use a greater portion of their incomes on mortgage payments. If those regions suffer more layoffs or wage cuts, credit problems could grow, especially since lending standards have changed during the last economic pullback, the FDIC said.
"Developments contributing to increased credit risk include higher consumer-debt burdens, looser mortgage loan underwriting standards, and the emergence of subprime mortgage lending as a significant line of business for some banks," the FDIC said in its report.
While all this hints that the housing sector is cooling off, right now it seems less a bubble bursting than an overextended sector giving off little burps to release excess pressure gradually.
Given the housing sector's Herculean performance last year and its record months in January and February, the very strength that has so impressed economists until now could make for a disappointing spring, however.
Home building normally flourishes in the spring as builders, waylayed for months by winter's chill, get back to work. This time around will be different for the same reason many economists expect anemic consumer spending this year: lack of pent-up demand.
Much warmer-than-normal temperatures across the U.S. meant that builders never stopped hammering. "Because of the weather and the declining interest rates, it was really borrowing from the normal spring upturn," Mr. Paris said.
Therefore, the economy, which normally gets a big lift coming out of a recession from sectors like housing and autos, both which performed spectacularly last year, won't get that usual shot in the arm.
"In the current brief recession, the housing-market indicators were in record territories. Going forward, there will be little addition [to GDP] from the housing market. Government spending and business-investment spending will come around, but housing will not be a contributor," said Lawrence Yun, senior economist for the National Association of Realtors. "However, it will not be a major subtraction, either."
The economy could see further drag from the housing sector if home prices keep dropping. The "wealth effect," as it's known, is the propensity of consumers to spend more if they have more assets. If home values slip, so might Captain Consumer's as-yet bulletproof determination to spend, spend, spend, which helped keep the economy from a longer and deeper recession last year.
Moreover, refinancings are expected to decline. The Mortgage Bankers Association of America expects that mortgage originations will drop to $1.470 trillion this year from $2.030 trillion in 2001. Of those, about 38% are expected to come in the form of refinancings, compared to 57% last year.
Mortgage refinancings typically boost the economy as money that consumers save or gain finds its way back into the marketplace.
Still, market watchers say this is all factored into estimates for economic growth this year, and longer-term, most economists are still bullish on the housing market.
Doug Duncan, chief economist for the Mortgage Bankers Association, says he's "not in the camp that says there is a bubble," but he does anticipate a 7.5% 30-year mortgage rate by the end of the year and 2%-3% drop in home sales. Meanwhile, housing prices will go up, he says, but only at about half the rate they did last year.
However, Mr. Duncan says census data suggest another housing boom is possible in the next 10-15 years.
Of Americans ages 45-54, there are about 20.7 million households, and of those, there's a home-ownership level of about 76%. In the next youngest group, those ages 35-44, there are 24.4 million households, but only a 67% home-ownership level so far.
"That's a big bulge of demand coming in the next ten to fifteen years," Mr. Duncan said.
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