(well "balanced") WSJ piece on real estate "booms" and "busts" ............................
[I'm not used to seeing "balanced" articles on this topic. Jon.]
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August 17, 2005
Lessons From Busts Gone By
By JON E. HILSENRATH and JAMES R. HAGERTY
Staff Reporters of THE WALL STREET JOURNAL
Banks promote exotic mortgages, tiny apartments sell for outrageous prices, and regulators worry about loose lending standards.
The U.S. in 2005? No, Japan in the early 1990s, when banks helped people purchase increasingly expensive homes by, among other things, issuing 100-year mortgages that were meant to be paid off by later generations. Japanese authorities halted the boom by raising interest rates and tightening lending standards -- ushering in a long, slow property decline.
There are plenty of differences between Japan then and the U.S. today. But a search through boom-bust cycles of the past -- from Tokyo to California to Boston -- offers lessons about today's real-estate boom and how it might play out.
People who have studied past busts point to two main causes: a drying up of liquidity -- often through tighter lending standards or higher interest rates -- or a serious economic shock, like an oil or currency crisis.
Property booms themselves don't guarantee a bust. In a study of housing booms in 14 advanced economies during the past 35 years, the International Monetary Fund found that at least a third didn't bust. But in countries experiencing a nationwide real-estate bust, the consequences can be drawn out and severe. All but one have been associated with recessions, and many have been tied to banking crises as well.
"History can tell you how bad things can get and can give you some ideas about some of the causes of what happened," says Michael Bordo, a professor of economic history at Rutgers University in New Brunswick, N.J.
Here are some important signposts:
'Refuse to Lose': People often act irrationally when housing markets go sour.
From 1982 to 1989, condo prices in Boston nearly tripled. Then demand dried up. But rather than cut asking prices, many owners decided to sit tight and hope. By 1992, fewer than 30% of Boston condos sold within six months, while hundreds languished at prices few buyers were willing to pay.
Christopher Mayer, a Columbia University economist who studied the Boston boom and bust, found that through the early stages of the downturn, people had a strong aversion to selling at a loss, even if such a sale would have freed them to buy another house in the same market on the cheap.
"Psychology is impairing their ability to make good economic decisions," says Prof. Mayer. Economists call this "loss aversion" -- people are much more unwilling to face reality and sell losers than they are to sell winners. He says it's the key factor that makes real-estate markets so slow to adjust in a downturn.
Refusing to sell at a loss is the main reason people freeze up. Others can't afford to sell: Their mortgage balances are higher than the price they could get.
That's what happened to Kathryn McMiller, a consultant who helps hospitals manage information. People were camping out to be first in line for new homes when she bought a $130,000 condo in Trabuco Canyon, Calif., in 1991. Her plan was to sell the condo after a few years at a big profit so she could afford a bigger home with a yard.
Shortly after her purchase, however, prices began declining. Within a few years, some condos identical to hers were going for $90,000. "I couldn't afford to sell," says Ms. McMiller. The proceeds wouldn't have covered the amount she owed on her mortgage. So she stayed put until 1999, when the market recovered enough for her to sell for about the same price she paid in 1991.
Follow the Money: To understand a boom, you need to understand its enablers. In property booms, it tends to be the banks.
Susan Wachter and Richard Herring, economists at the University of Pennsylvania's Wharton School, say bankers in the past have tended to suffer from "disaster myopia," an inability to envision worst-case scenarios during long stretches of good times. That encourages them to loosen lending standards.
Japan's long economic boom provided fuel for jusen, specialized home lenders such as Nippon Housing Loan Co., creator of the 100-year mortgage, which was supposed to be paid off by the borrower's grandchildren. "There needs to be fuel for a boom, and banks historically provided that fuel," says Prof. Wachter.
In the U.S. today, banks are selling increasingly exotic mortgages, such as interest-only loans and loans that backload interest and principal payments. But the key difference is they don't hold the loans; instead, many sell them off to investors as bonds. That does protect individual banks, but it could spread the risk throughout the financial system.
Location. Location. Location: As homeowners in Cleveland and Dallas will tell you, there is no housing bubble in many parts of the country. On a scale much smaller than the U.S., something similar was true in Hong Kong a decade ago: Average prices soared 61% from 1995 to 1997. But even though Hong Kong is just a few times the size of Washington, D.C., price increases varied widely, ranging from 28% in some buildings to 248% in others.
"It is surprising how much variation we can find in such a small place," says Grace Wong, a professor at the Wharton School's Zell/Lurie Real Estate Center. She found that as Hong Kong's handover to China approached, districts with more pro-China leanings faced less political uncertainty and thus less market speculation, resulting in more modest price increases.
A study of regional U.S. housing bubbles by Friedman, Billings, Ramsey & Co., an Arlington, Va., brokerage firm, found that in the period from 1987 to 1994, bubbles in 42 metropolitan areas lasted anywhere from one to 31 quarters. Median house prices subsequently fell by as much as 39%, but in some areas they didn't fall at all. "It is striking that the durations of bubbles and the magnitudes of the subsequent declines in house prices vary so widely," said Michael Youngblood, the author of the report.
The Dog That Didn't Bark: Not all booms end in a housing bust.
Declining oil prices shocked the Texas economy in the 1980s, and defense cutbacks in southern California hurt the Los Angeles job base in the early 1990s, causing nasty housing busts in both cases. So when the technology bubble burst in 2000, home prices in the tech-dependant San Francisco Bay area seemed primed to fall. But they haven't. Five years after the bust, the median sales prices of existing San Francisco homes were 41% higher, at $641,700.
The house price bubbles that Friedman Billings Ramsey found from 1987 to 1994 ranged from Boston to Tallahassee, Fla., to Tucson, Ariz. But in 14 markets, the bubbles never burst, including in many of today's frothy markets, such as San Diego, Santa Barbara, and San Jose.
Write to Jon E. Hilsenrath at jon.hilsenrath@wsj.com and James R. Hagerty at bob.hagerty@wsj.com
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