- The Washington Times - Tuesday, August 27, 2002

The unusual strength of housing, fed by the lowest interest rates in a generation, is a boon to homeowners but raises concern that a bubble in home prices will burst and drag down the economy.
Reports released yesterday showed new-home sales surging by 6.7 percent to a record rate of more than 1 million last month, while sales of existing homes rebounded by 4.9 percent after two months of declines. When combined, sales are on track to hit a record of about 6.36 million this year.
Those strong sales have stoked large gains in home prices in recent years. Existing-home prices were up by 7.3 percent nationwide in the past year and have soared by 20 percent to 30 percent in Washington, New York, San Francisco and other major cities.
Price gains softened slightly this summer with the rest of the economy. But the unprecedented resilience of housing in the face of recession and economic weakness has raised fears that it is in a bubble like the one seen in the stock market in the late 1990s.
"I think we're in the middle of a bubble" that could end badly, with home prices tumbling in 2003 or 2004, said Ed Yardeni, chief investment strategist with Prudential Securities.
He noted that Americans boast about the jumps in their home values much like they talked about their big technology-stock gains during the 1990s, much of which have evaporated.
But calling the housing bonanza a bubble is "controversial," he added, partly because the extravaganza, while it lasts, provides benefits to many people, including homeowners, banks, insurers and appliance-makers.
"There's no way around it. This is the Garden of Eden for consumers," he said, and the growth of housing has helped keep the economy afloat this year and last, despite record bankruptcies and weakness in other sectors.
Home values ballooned to $6 trillion nationwide, even as the stock market imploded and lost $7 trillion of value in the past 2 years. That left most consumers better off, because two-thirds of Americans own homes, while only about half own stocks.
Americans have turned their growth in home value into cash through cash-out refinancings and home-equity loans, aided by the lowest home mortgage rates since the 1960s. The average rate on a 30-year mortgage hovered near its record low of 6.3 percent this week.
The amount of home equity turned into cash through second mortgages doubled in the past two years to $200 billion, enabling consumers to keep spending during the recession and fueling other big-ticket purchases such as automobiles, Mr. Yardeni said.
But consumers and banks could suffer a setback if the housing market is hit with sharply higher interest rates or other developments that cause a sudden loss of buyers and send prices down the classic bubble scenario.
Consumers would be immobilized by falling prices and loss of purchasing power, and lending would dry up as banks struggled to cut their losses and remain solvent.
Some economists worry that the credit crunch and consumer retrenchment resulting from a housing bust, coming on top of the stock market and investment debacle of the past two years, would be severe enough to send the economy back into recession.
They point to the example of Japan, which has experienced only recession and stagnation in the decade since its twin bubbles in stocks and real estate burst. Others say the U.S. economy has avoided the extremes and rigidities that worsened Japan's predicament.
"To be sure, there are housing bubbles in some parts of the country, but an economywide setback in house prices leading to a recession is unlikely," said Sung Won Sohn, chief economist with Wells Fargo & Co., the nation's largest mortgage lender.
Despite the record amount of mortgage debt consumers are carrying, he noted, outstanding mortgages account for only a quarter of home values. That leaves consumers with "plenty of cushion" should prices fall, he said.
Federal Reserve Chairman Alan Greenspan has also dismissed worries that housing is in a bubble, arguing that home prices are not as speculative as stock prices and cannot escalate as much because of the conservative lending practices of banks.
Although investors were able to bid up stock prices by hundreds and even thousands of percents in the 1990s, banks closely scrutinize home prices to ensure they are not out of line, and they will not allow homeowners to finance purchases beyond their means, Mr. Greenspan said in congressional testimony last month.
But although the Fed chairman and most other economists doubt that housing is forming a bubble nationwide, many concede that big-city markets could be overstretched and headed for a fall.
The short supply of houses for sale in Washington and other metro areas is caused partly by restrictions on development for environmental and political reasons. When combined with growing populations, the result is exaggerated price gains.
National Association of Realtors President Martin Edwards Jr., whose group puts out the existing sales figures, said, "There is a lot of pressure on home prices," but he believes it eased some this summer, "reducing the risk of localized price bubbles."
The median price of a home for resale last month declined 0.7 percent, to $162,800 nationally, while the median price of new homes fell to $170,500, from $186,200, mostly reflecting a shift from higher-priced homes into moderately priced housing, according to the Commerce Department.
Joel Naroff of Naroff Economic Advisers said the housing market is not in a bubble but that home prices could nevertheless fall in some areas if the economic recovery picks up speed and interest rates rise.
"The low mortgage rates have clearly driven demand up to incredible levels," he said. "When mortgage rates move back to more normal levels, that will test not only demand, but also prices."

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