Bubble babble (re: "Housing bubble")

Town Hall ^ | July 28, 2005 | Alan Reynolds

[Sonny M]

In economics, bad metaphors often lead to bad policies. As I explained years ago in The American Spectator: "Inflation is never a thermal condition described by 'overheating,' nor a budgetary consequence of 'guns and butter.' Monetary policy is never in the position of 'pushing on a string,' and government borrowing never 'primes the pump' or 'kick starts' entrepreneurial spirits. Booms need not lead to busts (Hong Kong boomed continuously from 1975 to 1997), and busts need not be preceded by booms (witness the United States in 1937). Most important, large increases in asset prices are never inexplicable 'bubbles' that collapse for no reason, or that need to be burst by a central bank assault. These crude metaphors are just journalistic tricks for concealing ignorance, but they regularly foster poisonous remedies for imagined ills."

Since 2002, when the metaphor of a "housing bubble" began to stick to reporters like Bubblicious gum on their shoes, they have continued quoting the same Chicken Littles warning about an imminent and supposedly disastrous collapse of housing prices. People who are most worried that house prices have been rising too fast appear even more worried that houses prices might stop rising.

In this journalistic rivalry to blow the bubbliest bubbles, some seized on a comment in Alan Greenspan's testimony about "potential for individual disaster" for overleveraged homebuyers. Yet the key word was not "disaster," but "individual." Greenspan said if home prices did decline in localized markets, "the macroeconomic implications need not be substantial. ... Moreover, a decline in the national housing price level would need to be substantial to trigger a significant rise in foreclosures, because the vast majority of homeowners have built up substantial equity in their homes."

Why is even the slightest rollback of asking prices on homes supposed to be such an ominous threat? The most revealing answer came from New York Times writer Anna Bernasek in "Hear a Pop? Watch Out." She began with a hypothetical wealth effect. "Economists use this rule of thumb: A $1 change in household wealth leads to a roughly 5-cent change in consumer spending. By that measure, a 10 percent decline in real estate prices would knock about half a percent off the gross domestic product."

This wealth effect results from single-entry bookkeeping -- looking only at sellers and ignoring buyers. The wealth of young couples mainly consists of their future earnings, or "human capital." High house prices reduce that wealth for first-time homebuyers by as much as they raise financial wealth for sellers.

Those trading one home for another are both buyers and sellers, so the net effect on their wealth depends on whether home prices are most inflated in the place where they are buying or selling. For those changing homes in the same area, a lower price on the house being sold would be largely offset by a lower price on the one being purchased, with little net wealth effect. If home prices softened sufficiently to make selling less attractive, then fewer people would put their homes on the market and the resulting scarcity would limit any price decline.

Bernasek went on to fret that "a fall in values ... would probably lead to tightened credit standards, less lending and higher interest rates." Yet her sources believe "the most attractive way for policy makers to cool the housing market would be to put pressure on lenders to tighten their credit standards" and for the Fed to "nudge the long end of the market toward higher rates." Their proposed solution is identical to the assumed problem.

Bernasek warned of "a new wild card for the economy. In 2004, adjustable-rate mortgages made up a third of new mortgage originations. No one knows what the effect of the widespread use of ARMs would be in a down market." But ARMs only amounted to 17 percent of outstanding mortgages in 2004, though they have often made up a third of new mortgages. ARMs made up 36 percent of new mortgages in 1995, according to the Office of Federal Housing Enterprise Oversight (OFHEO). And 1995 was in the middle of a "down market," according to an April 2003 IMF study she cites.

"Reviewing the experience in the United States and 13 other industrialized countries," she notes, "the IMF found that a real estate bust is far more dangerous to the economy than a stock market bust." But the United States never experienced a housing bust, according to the IMF, because "to qualify as a bust a housing price contraction had to exceed 14 percent."

Those "more dangerous" cases the IMF was talking about were in places like Australia 1974-78, Norway 1976-83 and Denmark 1989-93.

It is unsurprising that the IMF discovered house prices were "associated with" recessions, because recessions result in lost jobs and reduced incomes. Turning cause and effect backward, housing bust theorists suggest housing prices just spontaneously collapse for no reason and therefore cause recessions.

The IMF finds economic busts and housing busts share one common explanation. "Housing price busts were (more) associated with tighter monetary policy than equity price busts, reflecting the fact that most housing price busts occurred during either the late 1970s and early 1980s or the late 1980s, when reducing inflation was an important policy objective." That lesson is notably irrelevant to this country at this time. Aside from energy, U.S. consumer inflation was 11.1 percent in 1980 and 5.2 percent in 1990, but is only 2.2 percent today.

According to the IMF, U.S. housing suffered two mini-busts between the first quarter of 1994 and the third quarter of 1996. OFHEO indexes of house prices by state, however, show that particular decline was dominated by California. From the third quarter of 1990 to the third quarter of 1996, average prices of existing homes in California fell 13 percent. Why? The unemployment rate in California jumped from 5.1 percent in January 1990 to 6.8 percent that December, then to 8.3 percent a year later and to 9.9 percent a year after that.

California unemployment remained consistently well above the national average and did not dip below 9 percent until March 1994. This June, by contrast, California unemployment was down to 5.4 percent, and below 4 percent in San Diego, so it is not entirely surprising that long-depressed California housing prices have since rebounded by 164 percent from the IMF's 1996 trough.

If unemployment in California once again rose above 9 percent, housing prices would surely fall again, as in 1990-96. But a weak state economy rather than the resulting glut of homes for sale would then be the fundamental problem.

Those now predicting a nationwide drop in home prices that is even remotely comparable to what happened in California in the early '90s must at least explain what chain of events they imagine might make interest rates and/or unemployment soar. Otherwise, all this overinflated rhetoric is no more than a bunch of bubble babble.

[Sonny M]

I still get annoyed seeing how real estate is treated like its a macro-economic issue when it is really, a micro-economic issue.

Forget this "Interconnected eco-systems" crap, what happens in the state of Idaho real estate wise, has no effect what so ever, on what happens in NYC.

Sure some parts of the country might have housing bubbles, but other parts of the country do not.

The idea of giving pain to everyone so someone somewhere, will some how be better off, is altruistic sadism to the highest degree.

Repeat after me, Bubbles are not everywhere, just because it might be somewhere does not mean its also right here.

If your neighborhood goes boom, does not mean mines goes bust, especially if you live on the other side of the country, and if I go boom, doesn't mean you do to.

[dhs12345]

Wonder if baby boomer's retiring will have an impact on the housing market... as more and more move to retirement communities.

Then again, they may stay in their houses.

[Black Tooth]

Sure some parts of the country might have housing bubbles, but other parts of the country do not.

Some might, other parts do not?

Does this make sense?

Where I am real estate is strong, and the demand is endless.

As American goes from a country of 300 million, to 1 billion....Those looking for the great deal, will have a long wait.

[IllumiNaughtyByNature]

Wonder if baby boomer's retiring will have an impact on the housing market

There will be a run on condo's, townhomes and apartments when the boomer downsize and a glut of the larger homes they moved up to. Read "Boomernomics" (author?)it was a great book about 5 years ago about the economic impact of the boomers. IMO

[SF Republican]

If your neighborhood goes boom, does not mean mines goes bust, especially if you live on the other side of the country, and if I go boom, doesn't mean you do to - what is the old line? recession is when your neighbor is out of work, depression is when you are.

[oldtimer]

The NW Florida/Alabama Gulf Coast is a case in point. Destin prices have reached as much as $1,000 sft, and the demand has shot across to Orange Beach/Gulf Shores to as much as $800 sft.

Condo construction is breathtaking, and after Hurricane Ivan, a number of condos are still under repair.

There will be capacity plus in the next 12-18 months.

Add the interest rate hikes that Greenspan is working on, and I see trouble ahead.

[dhs12345]

Thanks. Will do.

[dhs12345]

http://www.amazon.com/exec/obidos/tg/detail/-/0345425839/104-4483214-8916718?v=glance

[Jaysun]

Thanks for this. The hysteria over the supposedly doomed housing market is sick.

[IllumiNaughtyByNature]

Yes, that's the book and half.com is the best placwe to buy books, but you knew that.

[Pessimist]

I disagree w/ this article in so many ways. For instance:

""the most attractive way for policy makers to cool the housing market would be to put pressure on lenders to tighten their credit standards" and for the Fed to "nudge the long end of the market toward higher rates." Their proposed solution is identical to the assumed problem"

No, its not. And I'm sure the author knows it. Tightening credit to slow inflation in home prices it not at ALL the same as inflated home prices due to easy credit.

Similarly, he seems to completely miss (or at least misstate) the impact of ARMS on an already credit saturated population. Small rises in the interest rate could easily force many marginal borrowers (you know who you are...) into foreclosure, immediately depressing the value of the homes in question as well as diminishing their capacity to spend on other goods.

I'm pretty sure that's obvious.

[narby]

Wonder if baby boomer's retiring will have an impact on the housing market... as more and more move to retirement communities.

Another good reason to buy real estate in "retirement" areas.

I know that Flagstaff Arizona and other "nice" places to live are booming. And Detroit is busting.

What I wouldn't give to have bought property in Jackson Hole Wy about 8 years ago.

[GOP_1900AD]

You do have a good point. I would say that here in California, the overpricing drives some fairly risky mortgages, whereas, in less expensive places, such mortgages are not taken. If there is a correction, it may well not be nation wide.

[Atlas Sneezed]

Some big factors in housing prices:

Environmentalism (and NIMBY "I was here first" zoning), which close vast areas of usable land (increasing lot costs).

Inflation. The interest rate controllers may pretend otherwise, but we have inflation. And anyone who built a home over the last year or two can tell you that essentially every material has substantially increased.

[truth_seeker]

"Wonder if baby boomer's retiring will have an impact on the housing market... as more and more move to retirement communities."

Sure it has an impact.

Many retirees leave a higher priced home, extract equity, move to a lower priced location.

Retirees are among the many moving to the fast growing places, in the south and west.

And many boomers are making the move well before retirement--upgrading their lives, by getting out of the hectic, fast paced bigger cities and bigger suburbs.

For me, it would be sell in Orange County, CA and to go to Flagstaff, Prescott, Cottonwood or St. George.

[mlmr]

Anyone interested in purchasing my three family, on the East End near the Eastern Prom in Portland Maine? 400K?

[xzins]

How to determine if there's a housing bubble.

1. Houses are used for living in....generally for 3 or more years to lifelong.

2. When houses are bought and put on the market again within months for markedly higher prices, then rest assured that someone's using the house to make a killing and not to live in.

The author knows a lot. But it's just common knowledge that houses are a FUNCTIONAL piece of property.

[durasell]

The money that runs through the mortgage system is all connected. It's like looking at a wire fence after a snowstorm: you might see the tops of the fence poking out at regular intervals, but don't see the wire connecting them.

Also, housing booms on the coasts have sparked local economies and businesses far away. This would include timber and siding as well as fixtures. And, too, money being extracted from home equity has purchased products that have kept many factories humming, both here and abroad.

[DB]

Ya, but your a Pessimist ;-)

[bill1952]

Condo construction is breathtaking, and after Hurricane Ivan, a number of condos are still under repair. There will be capacity plus in the next 12-18 months.

Guy, demand is breathtaking also, and way down here in Port Saint Lucie, where I moved to in 81, (and shortly thereafter started buying all of the raw land that I could) the prices have skyrocketed.

Hmm, PSL is now the fastest growing city in the Nation and shows no slackening in growth.
Lots that I brought for 2,000 and change now routinely go for 100,000+.

These are not regional anomalies, this is the trend. The trend is your friend, as I sometimes say.

The main difference that I see with rising interest rates will be a change from a sellers market to a buyers.
Is that trouble?

Toys