Homes: Hot Markets Get Hotter

[HenryTo]

Reminds me of the narrowing breadth of the stock market from April 1998 all the way up to March 2000:

http://money.cnn.com/2005/05/12/real_estate/metro_home_prices_up/index.htm?cnn=yes

[HenryTo]

Argues that we are now in a housing bubble and that a bursting of such bubble can result in an economic recession very much unlike the one we saw in late 2001.
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Op-Ed Columnist
Running Out of Bubbles

By PAUL KRUGMAN
Published: May 27, 2005
Remember the stock market bubble? With everything that's happened since 2000, it feels like ancient history. But a few pessimists, notably Stephen Roach of Morgan Stanley, argue that we have not yet paid the price for our past excesses.

I've never fully accepted that view. But looking at the housing market, I'm starting to reconsider.

In July 2001, Paul McCulley, an economist at Pimco, the giant bond fund, predicted that the Federal Reserve would simply replace one bubble with another. "There is room," he wrote, "for the Fed to create a bubble in housing prices, if necessary, to sustain American hedonism. And I think the Fed has the will to do so, even though political correctness would demand that Mr. Greenspan deny any such thing."

As Mr. McCulley predicted, interest rate cuts led to soaring home prices, which led in turn not just to a construction boom but to high consumer spending, because homeowners used mortgage refinancing to go deeper into debt. All of this created jobs to make up for those lost when the stock bubble burst.

Now the question is what can replace the housing bubble.

Nobody thought the economy could rely forever on home buying and refinancing. But the hope was that by the time the housing boom petered out, it would no longer be needed.

But although the housing boom has lasted longer than anyone could have imagined, the economy would still be in big trouble if it came to an end. That is, if the hectic pace of home construction were to cool, and consumers were to stop borrowing against their houses, the economy would slow down sharply. If housing prices actually started falling, we'd be looking at a very nasty scene, in which both construction and consumer spending would plunge, pushing the economy right back into recession.

That's why it's so ominous to see signs that America's housing market, like the stock market at the end of the last decade, is approaching the final, feverish stages of a speculative bubble.

Some analysts still insist that housing prices aren't out of line. But someone will always come up with reasons why seemingly absurd asset prices make sense. Remember "Dow 36,000"? Robert Shiller, who argued against such rationalizations and correctly called the stock bubble in his book "Irrational Exuberance," has added an ominous analysis of the housing market to the new edition, and says the housing bubble "may be the biggest bubble in U.S. history"

In parts of the country there's a speculative fever among people who shouldn't be speculators that seems all too familiar from past bubbles - the shoeshine boys with stock tips in the 1920's, the beer-and-pizza joints showing CNBC, not ESPN, on their TV sets in the 1990's.

Even Alan Greenspan now admits that we have "characteristics of bubbles" in the housing market, but only "in certain areas." And it's true that the craziest scenes are concentrated in a few regions, like coastal Florida and California.

But these aren't tiny regions; they're big and wealthy, so that the national housing market as a whole looks pretty bubbly. Many home purchases are speculative; the National Association of Realtors estimates that 23 percent of the homes sold last year were bought for investment, not to live in. According to Business Week, 31 percent of new mortgages are interest only, a sign that people are stretching to their financial limits.

The important point to remember is that the bursting of the stock market bubble hurt lots of people - not just those who bought stocks near their peak. By the summer of 2003, private-sector employment was three million below its 2001 peak. And the job losses would have been much worse if the stock bubble hadn't been quickly replaced with a housing bubble.

So what happens if the housing bubble bursts? It will be the same thing all over again, unless the Fed can find something to take its place. And it's hard to imagine what that might be. After all, the Fed's ability to manage the economy mainly comes from its ability to create booms and busts in the housing market. If housing enters a post-bubble slump, what's left?

Mr. Roach believes that the Fed's apparent success after 2001 was an illusion, that it simply piled up trouble for the future. I hope he's wrong. But the Fed does seem to be running out of bubbles.

E-mail: krugman@nytimes.com

[HenryTo]

A speech from Fed Vice Chairman Roger Ferguson. In my mind, there is really no question that real estate is in a bubble in parts of the country - said parts including California, Nevada, Arizona, and now in Austin, Texas as well. The latest Fortune article on this is a must-read. Stories of people who have trouble finding their "homes," and couples not knowing how many properties they have, etc.

I've seen studies where the median price of a home is compared to the S&P 500 Index and the conclusion was that housing is not in a bubble - given that the median price of a home here in the United States has severely underperformed the S&P 500 on a historical basis. That is true in most parts of the country but the bubble is in the fringes - not unsimilar to the bubble in tech in the late 1990s. Comparing the median price of a home to something is similar to looking at the median market cap of U.S. public companies and concluding that the S&P 500 is undevalued or overvalued. These kind of studies do not make too much sense to me.
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Link between Fed, bubbles tenuous
Ferguson: Home prices in some U.S. markets 'relatively high'
By Rex Nutting, MarketWatch
Last Update: 1:31 PM ET May 27, 2005


WASHINGTON (MarketWatch) - The jury is still out on whether easy money policies of the Federal Reserve could be fueling a bubble in U.S. real estate prices, Fed Vice Chairman Roger Ferguson said Friday.

Nevertheless, Ferguson warned that in some U.S. markets "the most prudent judgment is that the growth of house prices will slow from the rapid pace experienced most recently."

"Right now, housing prices in many markets in the United States are relatively high when judged by convention valuation measures," he said in prepared remarks. But Ferguson said it is difficult to know whether real estate is fairly valued.

In a speech in Berlin to a central bankers' conference, Ferguson said policymakers cannot know in real-time whether rising asset prices are caused by accommodative monetary policy or by more sustainable fundamental forces.

A copy of his remarks was made available in Washington.

Critics of the Fed have charged that its low interest rate policies are driving investors into real estate, fueling an unsustainable bubble in housing prices that could become a large drag on the economy if prices were to collapse.

U.S. home prices appreciated 11.2% in 2004, according to data from the Office of Federal Housing Enterprise Oversight.

Similarly, the critics say, the Fed fostered a bubble in technology stocks in the late 1990s, which led to the 2001 recession and subsequent tepid recovery in capital investment.

"There was a strong sense at the time that such elevated price levels were unusual, but there was no uniform consensus regarding whether of not they were sustainable," Ferguson said of Nasdaq 5000.

In his speech on "asset prices and liquidity," Ferguson tackled the issue head-on before concluding that the Fed and other central banks must continue to target stable consumer prices and not worry overmuch about asset prices.

He acknowledged that excesses in asset prices can disrupt the economy and diminish the effectiveness of monetary policy. "Risks of a policy blunder are heightened," he said.

"Clearly central bankers would benefit from a better understanding of asset price movements --- particularly more extreme movements - so that we do not mistakenly facilitate in some way potentially harmful outcomes," Ferguson said.

Empirical evidence does not support a clear connection between easy money and high stock prices, he said. But there is a clear connection between real estate prices and monetary policy, he said.

"Correlation is by no means causality," he said.

Evidence shows that housing prices tend to peak about two quarters after money growth peaks, Ferguson said.


Rex Nutting is Washington bureau chief of MarketWatch.

[HenryTo]

Are there still doubts about a housing bubble in certain parts of this country?
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Concerns Mount
About Mortgage Risks

Latest Data Show Move Toward
Alternative Loans Is More Pronounced
Than Previously Thought
By RUTH SIMON
Staff Reporter of THE WALL STREET JOURNAL
May 17, 2005; Page D1

In the latest sign of how frothy the housing market has become, new data show the degree to which people are stretching to buy homes in a hot housing market.

The data, from the Mortgage Bankers Association, show that adjustable-rate and interest-only mortgages accounted for nearly two-thirds of mortgage originations in the second half of last year. Both types of loans have helped fuel the strong housing market since they carry lower initial monthly payments than do fixed-rate loans, enabling borrowers to purchase more-expensive homes.

With such loans accounting for an increasing portion of consumer borrowing, some mortgage analysts worry that the growth of these loans could cause problems for the housing market and broader economy. "The situation with interest-only ARMs is just one of several very scary things going on in the mortgage industry," says Stu Feldstein, president of SMR Research Corp., a market-research firm in Hackettstown, N.J. The rise of interest-only loans, combined with other factors such as higher debt levels and changing bankruptcy laws, are likely to cause foreclosures to rise, he says, "possibly dramatically."

Though it has been clear that borrowers in high-priced markets have been gravitating to products that make homes more affordable, the shift has been greater than expected. In California, where home-price growth has been sizzling, interest-only loans accounted for 61% of the mortgages taken out to buy homes in the first two months of this year, up from 47.1% in 2004 and less than 2% in 2002, according to an analysis prepared for The Wall Street Journal by San Francisco researchers LoanPerformance, a unit of First American Corp. Just 18% of California households can afford to buy a median-price house using a conventional 30-year fixed-rate mortgage, according to a report issued this month by the California Association of Realtors.

In another report issued this month, mortgage strategists at UBS AG called the shift to ARMs and nontraditional mortgage products such as interest-only loans "symptomatic of...the end of the housing cycle. The thing that all of these loans have in common is that they allow homeowners to buy a more expensive home than they could have qualified for with a 'traditional' loan."

The Mortgage Bankers Association conducted the survey of the interest-only and ARM share of mortgage originations in an effort to provide more accurate information about the housing market. The group's survey found that interest-only mortgages accounted for 17% of loans originated in the second half of 2004. And 46% of loans were adjustable-rate loans that don't carry an interest-only feature. The data reflect dollars lent, not the number of mortgages.

This is the first time the group has measured the share of interest-only loans, in which borrowers lower their monthly outlay by paying interest and no principal in the loan's early years. It also is the first time it has looked at loans actually granted, not merely applications.

The findings are the latest evidence that borrowers have moved decisively away from traditional 30-year fixed-rate mortgages and have embraced ARMs and, in particular, interest-only loans, which used to be a niche product. Though borrowers take out these loans for many reasons, the shifts come at a time when both home prices and competition among mortgage lenders has climbed. The MBA's weekly surveys -- which look only at application volume, not loans that are actually made -- had put the share of ARMs, including interest-only loans, at roughly 40% to 50% this year. That is up from as little as 18% of application volume in early 2003.

The surge in ARMs and interest-only loans is particularly notable because rates on 30-year fixed-rate mortgages remain below 6%, still low by historical standards. Borrowers typically turn to ARMs as interest rates climb, but so far the increase in rates has been modest. Many economists see the current popularity of ARMs and interest-only loans as the latest sign of how borrowers are stretching to buy homes they couldn't otherwise afford -- and of how lenders are more than willing to accommodate them.

Partly because of these products, mortgage originations are expected to total nearly $2.5 trillion this year, according to the MBA, down slightly from $2.6 trillion in 2004.

Products such as interest-only mortgages can be riskier than fixed-rate mortgages, particularly when interest rates are rising. If home prices fall as rates rise, some borrowers with interest-only loans could wind up owing more than the value of their home. Even if the growth in home prices simply flattens or slows, some borrowers could be squeezed by rising mortgage payments.

In another sign that worries about lending practices are increasing, federal banking regulators yesterday issued new guidance for lenders making home-equity loans and lines of credit. The guidelines require banks to do a more in-depth analysis of borrowers' income and debt levels and their ability to repay the loan -- instead of relying simply on credit scores.

Initially aimed at sophisticated borrowers who wanted to free up cash for other purposes, such as investing in the stock market, interest-only loans have come to dominate some segments of the mortgage market. A report issued in January by UBS found that the interest-only share of jumbo loans -- currently, loans exceeding $359,650 -- had tripled since the end of 2003.

Michael Menatian, a mortgage banker in West Hartford, Conn., says he is seeing some borrowers opt for interest-only loans over mortgages that carry a lower interest rate but result in a higher monthly payment.

If home prices continue to surge, affordability could this year reach its worst-ever levels in hot markets such as Los Angeles, Boston and Miami, according to recent report by Goldman Sachs Group Inc. senior economist Jan Hatzius.

The MBA survey highlights other changes in the mortgage market that may increase risks to borrowers and lenders. More than half of the adjustable-rate loans were "traditional" ARMs, meaning the initial interest rate is fixed for less than three years. Borrowers who opt for these loans typically get a lower initial interest rate in exchange for giving up protection from future rate increases.

Until recently, so-called hybrid ARMs had been a more popular choice. These loans typically carry a higher initial interest rate, but are considered a more-conservative option because the interest rate is fixed for the first three, five, seven or 10 years. That makes it more likely that the borrowers will move or see their incomes increase before they face higher payments.

The shift to short-term ARMs has occurred even as the difference between rates on ARMs and fixed-rate loans has narrowed, reducing the attractiveness of adjustables. "To have a lower initial monthly payment, people have gone for shorter-term ARMs," says Fannie Mae Chief Economist David Berson.

As the use of more novel lending programs becomes commonplace, some mortgage analysts worry that borrowers are adding to the risks by combining a number of features -- using, for instance, 100% financing and an interest-only mortgage or a no- or low-documentation loan to buy a property for investment. "These things layer on each other," says Mark Milner, senior vice president and chief risk officer of PMI Mortgage Insurance Co., a unit of PMI Group Inc. During the past year, PMI has increased its charges for insuring riskier loans, Mr. Milner says.

Write to Ruth Simon at ruth.simon@wsj.com3