Ever
since the NASDAQ meltdown some folks have been waiting for the next big bad equity
story. Since most equity is found in peoples' homes, that's where pundits have
been focusing. They face disappointment however as they watch and wait for the
"house-price bubble" to burst. It's not
going to happen -- there isn't one. There has not been a single
year since World War II in which house prices across the United States have declined;
local markets, yes, but the whole United States, no (see chart). Homeowners know
this intuitively and view housing as a solid, if conservative, investment. After
all, you get to live in your house, you can't live in your stock portfolio, and
you do have to live somewhere. Since there are more and more of us living in the
good old United States, we will need more and more places to live. And the number
of us is growing faster than the number of houses. Ergo, no bubble! OK,
let's look at the issue a bit more systematically to see why from the economist's
point of view the issue is overblown. I work for the Mortgage Bankers Association
whose members make about 70 percent of all the home loans in the country, so it
is important that you see the logic in the argument against the "price bubble"
to overcome any suspicions of an inherent bias based on who I work for. Trouble
with the bubble
First, let's define the term bubble. The Oxford English dictionary
defines it as "a gas-filled cavity in liquid or in solidified liquid."
One might say it has form but no substance -- the outward appearance of something
substantial, but once the outside is pierced it is revealed to be based on a false
impression. In the case of home prices, the interpretation would be that current
home prices or price increases will be revealed to have been based on a false
impression and when the surface is pierced we will see a substantial fall in prices. About
the only way an economist can find agreement with that argument is by discussing
the role of expectations in decision making by consumers and investors. That is
to say, consumers and investors might engage in speculation that prices will continue
to rise as they have been (50 percent over the past six years), thus bidding house
prices above the level indicated by the current supply-and-demand fundamentals.
This speculative bidding would be for the purpose of capturing gains unrelated
to their need for housing. To confirm that this is happening, there would need
to be evidence that there was a growth in the number or share of residential home
sales that were sold to purchasers not intending to live in them. It is difficult
to find any confirmation of such a trend in the current market. Another
way an economist would accommodate your thought that home prices might unexpectedly
fall is if you argue that interest rates will rise rapidly and far enough to make
people stop buying houses. The economist would call this an affordability issue,
not a price bubble. Roughly nine out of 10 people who buy a house do so by borrowing
money. When interest rates rise, the monthly payment on a given amount of borrowed
money rises also and can exceed the maximum size payment the family budget can
support. This can change the balance between the cost to rent and the cost to
buy. The attached chart shows the recent relationship between average monthly
rent and average monthly after-tax mortgage payments and gives a good picture
of why people are buying homes. Article continued at http://www.bankrate.com/brm/news/real-estate/20030918a1.asp More
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