A countrywide meltdown in housing prices could have a profound affect on the economy, as more Americans invested in real estate than in stock. According to the Federal Reserve, homes' appraised value made up 145% of nominal gross domestic product in March, while stocks and mutual funds were worth 82% of GDP.
The bubble question isn't an easy one, even for economists. BusinessWeek Online's June Kim spoke with several economists for their thoughts on whether a housing bubble exists. The following are edited excerpts of their comments:
Frank Nothaft, chief economist, Freddie Mac:
I don't foresee any national decline in home price values. Freddie Mac's analysis of single-family houses over the last half century hasn't shown a single year when the national average housing price has gone down. The last consistent drop was during the Great Depression, when the unemployment rate got up to 25%, or five times the level we're at now.
Housing is local, local, local by nature, and it's the local economy driving valuation of a home. The large markets people think about -- New York, Boston, San Francisco, Los Angeles, and Washington D.C. -- where we've seen double-digit home-value gains in the last three or four years, are driven by economic growth and rising family income, coupled with a 40-year low in mortgage rates.
I would worry about local markets that have weak economies, where the unemployment rate has gone up over the last couple years, or where we have begun to see a bit more of a speculative fervor (by that I mean: A lot of investor vs. owner-occupant purchases).
WHO'S BUYING? An owner occupant lives in a home an average of 14 years. The average stock owner owns a share of stock for three months. You'll see much more volatility with common stock prices than in home prices.
Investor activity remains a small percentage of home purchases, representing at most 15% of purchases nationwide, vs. 85% of homes purchased by owner occupants.
If you see that investors are accounting for a third or a half of purchases in a local community, then I would be more concerned about speculative fervor. And I would expect stagnation in home-value trends in markets where unemployment is higher than 7%.
Dean Baker, economist and co-director of the Center for Economic & Policy Research:
We've never seen this sort of run-up in home prices in U.S. history. In the past, home prices have always moved pretty much at the same rate with inflation's overall rate. But in the last seven years, they've outpaced the rate of inflation by 60 percentage points. This kind of run-up becomes unsustainable (see BW Online, 6/22/05, "Builders Keep the Home Runs Coming").
Right now, the market is caught up in the psychology of a bubble. You see the fastest increases just before the collapse. If you look at the past, the Nasdaq crossed 4,000 around the new year in 2000, and then two months later, it had already crossed 5,000. Suddenly in mid-March, the Nasdaq plunged 15%, and it was downhill from there.
I don't think the housing market will follow exactly the same pattern, but in the case of the Nasdaq bubble, in February of 2000, people were having this same conversation, but were more focused on the fact that prices were rising more rapidly than ever.
HOUSING'S HUGE IMPACT. [Fed Chairman] Alan Greenspan recognized the stock bubble and was concerned about it, but he decided the best thing to do was not to attack the bubble, simply to let itself work it out and deal with the consequences. Given he had that attitude about stocks, I would assume he has the same attitude about housing.
Of course, houses don't risk dropping to zero value like the nonsense companies in the stock market did. But on the other hand, their value also has a lot of volatility.
A lot of economists, including Greenspan, say homes aren't like stocks and their prices aren't volatile. But what's odd is that ordinarily economists say the exact opposite. The housing market is thin, meaning that the number of potential buyers is relatively small compared to the number of potential sellers. A thin market usually means it's more volatile because fluctuations could be even bigger. While there's a current buying euphoria in the housing market, if a lot of people really take a beating, they may develop a phobia about becoming homeowners.
A decline in housing prices would have a very serious effect on the economy. Housing has been supporting the economy ever since the recession. Roughly 5% of the GDP is associated with homebuilding and construction. On top of that, we've had this huge consumption boom based on people taking out second mortgages and refinancing their homes spurring on the economy.
My estimates of bubble wealth -- the rate of growth of house prices exceeding the rate of growth of inflation -- come to around $5 trillion. Roughly 4% to 6% of that is $200 billion to $300 billion a year in housing-bubble-driven consumption. That's a lot to replace.
James F. Smith, chief economist at the Society of Industrial & Office Realtors:
There's no national bubble. You have to have a huge deflationary scenario to make a national bubble make any sense. The Fed isn't going to lose control of the money supply and take us back into a very significant deflation and cause a collapse in housing prices.
There are several reasons why a national housing bubble is relatively silly. According to census data, current home-ownership rates are at 69.3% of all households, a record. If you look at home ownership by age group, the highest rate -- above 83% -- are among owners aged 70 to 74. Only marginally below that is owners aged 65 to 69.
Nobody seems to look at how home ownership rises with age. The older we get, the higher the probability that we're going to own a house. If you look at the baby boomer generation, you get a picture of increasing demand that won't end for another 40 years.
DEMAND ON THE MARCH. Second, home-ownership rates are extremely high for white Americans, pretty high for Asian-Americans, have just gotten over 50% for African-Americans, and are slightly lower for Hispanics. But we have lots of programs to help minorities improve home ownership, so they're all increasing.
Thirdly, if you look at immigrant households with the same family size and income levels as households in which the parents were born in the U.S., immigrants buy houses 15 years later than natives. About one-seventh of the population is foreign-born, and [that group] has been growing rapidly the last 20 years. That gives you another 15 years of increased demand.
On top of that, mortgage rates are pretty darn low. The only way rates are going to rise is if inflation rises and the fear of inflation drives the 10-year Treasury up to 7% or 8%. Mortgages would go back to 9% or 10%, temporarily killing the housing market, but only temporarily.
It doesn't mean there aren't a few local bubbles in areas like Washington D.C., Los Angeles, suburban Boston, or suburban New York. But we've had many of those in the last 20 years or so. Texas collapsed in 1986, Southern California collapsed in 1989, and Massachusetts and Connecticut collapsed in 1991.
Mike Englund, chief economist at Action Economics, global bond and currency consulting firm:
It's not clear that the recent price gains in the housing market are a bubble. It's bubble behavior. There are many assets whose prices move quickly, but that doesn't mean it's a bubble.
In a global context, the rise in U.S. housing prices doesn't really stand out. The global economy, led by the U.S. and China, has posted a stellar growth rate. Last year was possibly the fastest pace of growth in post-World-War-II years. And much of the new economy features a synergistic global trade pattern between the U.S. and other countries. New York, Los Angeles, and San Francisco benefit from a new axis of global investors, and home prices there are being driven higher in the context of huge wealth and economic gains.
We're unlikely to see a price correction this year, since we're already well into the second-quarter period, a high-volume period for housing, and there's a clear price movement upward. It isn't until first or second quarter of next year that we're likely to see any correction.
With the Fed adding a quarter point [rate hike] per meeting, interest rates will trend from current low levels to average historic low levels next year. The question of whether that will pop the housing market is unclear. High-price housing markets may see a decline, but we seldom see price declines at the national level.