- The Washington Times - Tuesday, June 21, 2005

Rod Rodgers gets a feeling of deja vu watching D.C.-area home prices go up at double-digit rates while real estate agents tell him the gains can only continue.

The New York businessman and his two brothers recently inherited his mother’s house in Takoma Park. He has been thinking of buying out the other two so he can keep the family home. But he is balking at the sky-high prices.

“I feel like I’m on the edge of a knife,” he said. “I don’t want to get caught again like I did in New York” in 1989 when he bought an apartment at the peak of a housing bubble, only to watch helplessly as the price collapsed along with the housing market.

“It was catastrophic. I lost 60 percent” and had to rent out the place for nine years before it regained what it lost in value, he said.

Many homeowners and home buyers, while basking in the increased wealth and purchasing power brought on by skyrocketing home values, worry about the fallout if today’s white-hot real estate market suddenly cools and prices tumble.

Economists say the possibilities range from the dire to the merely inconvenient — from rising bankruptcies, defaults, foreclosures and a general recession to a leveling off of home appreciation for several years as higher interest rates cool the overheated market.

The possibility of a bad end to the housing boom emerged as a major concern of the Federal Reserve and bank regulators this spring. The Fed for the past year gradually has been raising short-term interest rates in part to gently let the air out of what appears to be a bubble in East Coast and West Coast housing markets.

But the Fed’s two percentage points of rate increases have been accompanied by an unusual and perplexing fall in long-term rates that has left the rates on 30-year mortgages near 40-year lows that continue to stimulate the housing market.

In an attempt to grapple with the rising risks another way, regulators last month started trying to persuade banks to curb the increasingly risky lending practices underwriting the housing boom.

A survey by the Mortgage Bankers Association found that 63 percent of mortgages originated in the second half of 2004 were of the riskiest types: either interest-only loans, in which no principal is paid in the first few years to lower initial monthly payments; or adjustable-rate mortgages, in which monthly payments start out low but can rise steeply as the Fed raises short-term rates.

Default risk rising

Regulators say the interest-only loans are a particular default risk, because buyers may end up with no equity in the home if prices fall, while the monthly payments on the loans eventually may double or triple as principal is added.

Beyond the hardship on borrowers, regulators are concerned that any real estate market collapse could cascade through the banking system, causing even healthy banks to pull back on lending.

As banks withdraw credit, consumers and businesses hit by a loss of wealth and high debt burdens retrench on spending, precipitating an economic downturn. In the 1930s, worse came to worst, many banks failed, and a decade-long Great Depression ensued.

Economists who fear the United States is experiencing a housing bubble point to the example of Britain, where a 122 percent run-up in housing prices starting in 1995 ended a year ago as interest rates started to rise.

British home prices have declined on average to $296,000 from a peak of $307,000 last June, according to a survey by the Hometrack research group.

Avoiding disaster

Many economists think the United States will avoid the worst as long as the economy keeps growing and unemployment stays low. They say that rising interest rates eventually will slow the housing market and cause housing prices to flatten in the years ahead.

“Short-term risks of price declines and rising defaults likely will remain low if the economy continues to expand,” despite the increased vulnerability of overstretched home buyers, said Nicolas P. Retsinas, director of Harvard University’s Joint Center for Housing Studies.

“When the economy hits a soft spot, though, housing corrections may be more painful than they would otherwise have been” because many buyers will encounter the “payment shock” built into their interest-only, sub-prime and adjustable-rate mortgages, he said.

Mark Vitner, economist with Wachovia Securities, says the housing market looks a lot to him like the stock market in the late 1990s, when a frenzy of investment in technology stocks traded on the Nasdaq Stock Market created a froth in prices.

In frothy areas of the housing market, including the District, California, Florida, New York and the Northeast, high valuations have been spreading and infecting the surrounding areas, he said.

Double-digit gains recently have come to Winchester, Va., Virginia Beach, Ocean City and other areas a same-day drive from the District, while the spillover effect from California’s red-hot market can be seen as far away as Las Vegas, Phoenix and Salt Lake City.

Outside the overheated areas on the East and West coasts, however, price gains have been relatively tame and should not experience severe setbacks, he said.

Bubble psychology

A bubble psychology is not always the reason for soaring prices in overheated areas, Mr. Vitner said. The District and some other major cities are experiencing rapid appreciation because restrictions on development and a lack of land available on which to build houses have created a shortage of homes for sale, he said.

In Atlanta, Houston and Dallas — three of the four most active home-building areas — prices have risen about 5 percent in the past year, less than half the national rate, largely because developers face fewer restrictions and can respond to the robust demand for housing, Mr. Vitner said.

A retrenchment in prices seems unlikely in those areas, he said, but “the markets that are currently seeing the largest gains in home prices … will most likely see outright declines.”

Even if the impact is limited, the economic problems caused by a housing bubble can be significant, Mr. Vitner said.

“Rapid home price appreciation opens the door to all types of potential problems,” starting with the risky loans buyers are using because they cannot otherwise afford to buy houses, he said.

The most serious consequences may be felt in areas such as the District and Miami, where a frenzy of speculation has taken over the condominium markets, he said.

In some apartment projects in Miami, condos change hands two to three times before the units are occupied, in the real-estate equivalent of day trading seen during the 1990s stock market bubble, he said. As much as 70 percent of new units are being sold to investors and speculators in such condo markets.

“We do think there are serious bubbles developing here that will have serious repercussions when they are unwound in a few years,” Mr. Vitner said.


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