The Housing Market's Solid Foundation


By Christopher Farrell The economy may be stumbling and the stock market floundering, but the American Dream is thriving. Americans are snapping up houses, remodeling their homes, and refinancing their mortgages at an astonishing pace.

The Mortgage Bankers Assn.'s index of mortgage applications rose by 3.6% for the week ended Aug. 3. The home has once again replaced equities as the single largest asset in the household portfolio, with the median home price up by almost 9% over the past year and the stock market down by 17%.

The housing market has shored up the economy during this latest downturn. In sharp contrast, housing has led every other precipitous decline in economic activity over the past half century. This year is shaping up to be the second-best housing market on record.

BEWARE THE BUBBLE. Does a nightmare lurk on Elm Street? Some economists worry the housing market is turning into a financial bubble, an unstable state of affairs that will eventually pop, with dismaying results. "I would not be surprised if all this leads to a new speculative bubble in housing in some parts of the country, or perhaps all parts with the exception of Silicon Valley, Greenwich, and the Hamptons," says Edward Yardeni, chief investment strategist at Deutsche Banc Alex. Brown.

There are some classic warning signs of an emerging mania. Home prices keep reaching new highs despite deteriorating fundamentals, such as a weak economy and widespread layoffs. The strong market is luring more people to stretch their finances and buy a home, with a median price tag of $146,900 in the second quarter.

Loans are turning sour at a troubling rate at banks that shoveled mortgage money at borrowers with poor credit histories during the economic expansion. Like the stock market in the late '90s, the housing market now seems to dominate financial discussions among friends, neighbors, and colleagues.

HEALTHY SIGNS. Yet the image of a bubble bursting isn't the right metaphor when it comes to housing. True, the current torrid pace of price appreciation is unsustainable. A handful of communities highly dependent on the high-tech industry for jobs are vulnerable to a sharp fall in prices. But the odds are that the housing market will simply cool off over the coming year, with price gains easing to a more restrained pace.

Housing is not a bubble in the making. Housing activity, while still strong, has actually been easing a bit recently. That's a healthy sign.

Why no boom and bust? The housing market frequently stalls, but prices rarely collapse like the Nasdaq in 2000 or oil prices in 1986. When prices drop too low, the supply of homes on the market is drastically reduced as many people take down their "for sale" signs. That reduced supply helps prop up the market. Both fixed-rate and adjustable-rate mortgages are at favorable levels.

Also, it's only when job losses skyrocket and personal incomes plunge that home prices spiral lower. For instance, the housing market was hammered during the Great Depression, and home prices in the Southwest's oil belt plummeted along with energy prices in the '80s. Today, the labor market appears to be stabilizing.

LONG-TERM SUPPORT. The government's latest job report was better than expected. The unemployment rate stayed stable at 4.5% and the 42,000-person drop in payrolls came in at about half the consensus expectation. Jobless claims for unemployment insurance have also plunged -- falling to 346,000 from a recent trend of some 400,000 -- although some seasonal-adjustment quirks probably exaggerate the improvement. Wages are up by 4.4% from a year ago, the best performance in three years.

The longer-term demographics are also positive. The "echo boomers" -- those in the mini baby boom of the mid '80s -- are getting close to adulthood, and they'll drive up demand for starter homes even as the original baby boomers trade up for bigger homes.

Immigrants and minorities are supporting the housing market in many metropolitan areas. Minorities will account for about two-thirds of household growth over the next 10 years, write economists at the Joint Center for Housing Studies at Harvard University in their latest annual report, "The State of the Nation's Housing." (You can download the richly detailed 40-page report at www.gsd.harvard.edu/jcenter.)

Add it all up, and the current mix of short- and long-term factors suggests housing will continue to support the economy. Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over National Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BW Online


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