NCPA Identifies Bubbles

According to this brief by the National Center for Policy Analysis, the housing markets in the bubble areas are accidents waiting to happen. But we in Marin don't have to worry. Right? I mean, we're special, right? This is God's country don't ya know. I mean, "housing in Marin has never gone down in price" (forget the last month or two), right? So that means it will never go down, right? Sure. Dream on Marin; keep being your inward looking self. But for the rest of us, I give you...

Some choice quotes:

"Speculative "bubbles" can appear in various sectors of the economy when the Federal Reserve eases monetary policy by lowering interest rates. Generally speaking, when the Federal Reserve tightens monetary policy, the sectors of the economy that went up the most during the easing phase will fall the hardest as the bubble bursts."

"The principal impact of the last easing phase, which began in January 2001, was on housing."

"Over the last five years, housing prices nationwide rose by an average of just over 50 percent. [See the figure.] But in some areas, prices have risen much more.

* In 13 states and the District of Columbia, home prices have climbed more than 60 percent. All of these states, except Nevada, border either the Atlantic or Pacific oceans.
* Home prices in California and the District of Columbia are up more than 100 percent."

"Based on the ratio of monthly rent to home sales prices, purchaseprices nationally are now almost 40 percent above where they should be. This abnormal price-to-rent ratio is driven partially by falling rents, not just rising home prices. Rents are falling because investors are purchasing many properties in hopes of rapid appreciation, increasing the supply of rental housing. And since much of this real estate has been purchased with interest-only or negative-amortization loans, investors don't need much rent to cover their payments."

"Last year, according to the National Association of Realtors, 23 percent of homes were sold as investments and another 13 percent were vacation homes. A prime motive for both types of purchases is rapid appreciation; thus, any falloff in housing prices could cause many of these properties to be dumped on the market quickly, potentially turning a housing downturn into a crash."

"Today, many of the economists who correctly predicted the stock market bubble would burst are saying that the housing market is in a bubble. If it collapses as the stock market did, the impact could be even more painful. That is because homeowners are much more leveraged than they used to be."

"Additionally, many homebuyers are making larger mortgage payments than their incomes will support."

"Furthermore, homeowners are increasingly buying and refinancing with unconventional loans, such as adjustable rate, negative amortization and interest-only mortgages, rather than traditional fixed mortgages. Such loans have lower initial payments, but rise automatically with interest rates. The Federal Reserve says that 47 percent of all residential mortgages by dollar volume are now nontraditional."

"Negative-amortization loans are especially dangerous, both for borrowers and those making such loans. This type of loan is a bit like a credit card, where the full amount need not be paid every month. As long as a small minimum payment is made, the balance can be rolled over. In this case, the unpaid balance is added to the outstanding mortgage."

"This reduces the buyer's cash flow expense, but also reduces the profit when the property is sold. Unless prices rise fairly rapidly, investors can easily end up with a mortgage that is greater than they can clear at closing. Consequently, even if prices simply level off, a lot of investors may find themselves with mortgages they cannot pay back after a sale."

Conclusion
"Owning one's own home is still the best investment that anyone can make. And if you plan to stay put for a few years, you shouldn't worry about a bust in the housing market. But those buying investment properties on either coast should be very, very careful. It may take a lot longer than they think to make money and they should be sufficiently well capitalized to ride out a market dip."

"Thus far, there is little evidence that the Federal Reserve's interest rate increases have had any effect either on financial markets or the real economy. Market interest rates, especially for mortgages, remain low while economic growth continues at a steady, if unspectacular, pace. However, it takes time for the Federal Reserve's policy changes to have their full impact and these lags vary."

"Furthermore, just because the Federal Reserve is raising rates gradually doesn't mean that the impact will be gradual. It could come quite abruptly. Think of a balloon. Whether you blow it up slowly or fast, at some point it is still going to burst. The same thing oftentimes occurs with monetary policy. It may appear that nothing is going on for a long time and then, suddenly, something dramatic happens."