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Politics and Economy:
Housing Boom or Bubble?
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Housing Boom or Bubble?

Newspapers, magazines and financial TV shows are full of speculation — is the superheated U.S. housing market a grand bonanza or a bubble about to burst? In an attempt to quiet some fears, the Mortgage Bankers Association released a study of the housing and mortgage markets on August 23, 2005. Among their conclusions:

There are a number of factors that reduce risk to the housing and mortgage markets: a strong economy, growing household net worth, a strong banking sector, well-functioning and liquid financial markets, widespread securitization, alignment of incentives with respect to loan defaults, the widespread implementation of technology, and effective regulatory oversight all work to mitigate risk.
Increasingly over the past few years THE ECONOMIST has taken the opposite view — warning of the possibility of a global downturn resulting from a faltering in the U.S. housing market. The magazine puts their theory starkly:
According to estimates by The Economist, the total value of residential property in developed economies rose by more than $30 trillion over the past five years, to over $70 trillion, an increase equivalent to 100% of those countries' combined GDPs. Not only does this dwarf any previous house-price boom, it is larger than the global stockmarket bubble in the late 1990s (an increase over five years of 80% of GDP) or America's stockmarket bubble in the late 1920s (55% of GDP). In other words, it looks like the biggest bubble in history.
Why the disparity?

The boom in housing prices is not limited to the United States: home price increases have reached historic levels all over the developed world. Many analysts trace the boom to two factors: low interest rates and a wariness toward stock market investing following the Internet bubble. The numbers are illustrative:

  • The U.S. homeownership rate is at a record 69% of U.S. households.
  • House prices in America are up by 65% since 1997.
  • The average price of homes in the U.S. jumped by 12.5% in 2004. In California, Florida, Nevada, Hawaii, Maryland and Washington, DC, they soared by more than 20%.
  • The cost of a median single-family home rose 15% from January to April, topping $200,000 for the first time, while the price of a condominium went up 18%. Rates of increase not seen since the 1970s.
But there are also numbers that serve some as warnings:
  • America's ratio of house prices to rents is 35% above its average level during 1975-2000.
  • House prices are also at record levels in relation to incomes.
  • Economists at Goldman Sachs point out that residential investment is at a 40-year high in America, yet the number of households is growing at its slowest pace for 40 years — createing excess supply.
  • A fifth of American mortgages in 2003 were for more than 90% of the purchase price.
Many analysts fear that the housing sector is supporting much of the nation's economy. It's called the "wealth effect" — consumer spending goes hand in hand with a hot housing market. As consumers feel more affluent and are willing to spend more and take on more debt. According to THE ECONOMIST, over the past four years, consumer spending and residential construction have together accounted for 90% of the total growth in GDP. And, over two-fifths of all private-sector jobs created since 2001 have been in housing-related sectors, such as construction, real estate and mortgage broking.

THE ECONOMIST points out that some financial authorities have recently voiced some worry about the housing market. Alan Greenspan, while discounting the notion of a national housing bubble, suggested there was "froth" in some markets. And, Jack Guynn, the head of the Atlanta Federal Bank, said he was 'uncomfortable' with residential speculation in some markets. Concerns center around both a possible over-valuation of real estate and the ability of homebuyers to keep up with payments for expensive properties. In addition, many are skeptical of new types of mortgages which rely on the housing boom continuing to raise home values indefinitely. Learn more about the new types of mortgages and read a Q and A with Allen Fishbein from the Consumer Federation of America about the new mortgage products. Also, get UCLA economist Christopher Thornburg's take on the California bubble.
Additional sources: Mortgage Bankers Association of America; THE WALL STREET JOURNAL; U.S. Department of Census Historical Statistics; The State of the Nation's Housing, 2005," The Joint Center for Housing Studies of Harvard University.

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