HOUSE PRICES CONTINUED THEIR RAPID ascent in early 2005, provoking yet another wave of charges about dangerous “bubbles” in U.S. housing markets as well as characterizations of housing as “the next NASDAQ.”
Everybody seems to know that housing markets are not as susceptible as securities markets to boom-bust patterns, but history clearly shows that house prices can fall substantially in local markets if something goes very wrong. On this point, a recent study by the FDIC titled “U.S. Home Prices: Does Bust Always Follow Boom?” provides some useful perspective.
The study looked at boom metropolitan housing 2003, defining “boom” markets as areas showing increases in real (inflation-adjusted) home prices of at least 30 percent over the previous three years. The authors conclude that such price booms don't last forever, that booms don't necessarily lead to busts, and that most booms end in periods of house price slowdown or stagnation that allow various economic fundamentals (including household income and housing supply) to catch up. In this regard, the limited number of busts were preceded by significant stress in local economies (not vice versa).
Special Risks? This time could be different, of course, and current bubble charges focus on the heavy presence of investors and speculators as well as the prevalence of “innovative” mortgage products that stretch affordability for home buyers, ease speculative purchases, and create potential problems for credit quality down the line.
These innovative mortgages include adjustable-rate loans with deeply discounted initial rates, with monthly payments even lower than accrued interest (generating increases in loan balances), with relatively high loan-to-value and debt-to-income ratios, and with little or no documentation of a borrower's assets, employment, and income (“low-doc” or “no-doc” loans).
Federal Reserve surveys document a systematic easing of lending standards on home mortgages at commercial banks since early last year. In May, the federal regulators of depository institutions issued an interagency supervisory letter titled “Credit Risk Management Guidance for Home Equity Lending,” which flagged many of the risky features that are prevalent in the markets for first mortgage loans as well. The heads of the Federal Reserve and the FDIC subsequently discussed the proliferation of adjustable-rate first mortgages that appear to erode underwriting standards and risk-management practices. Presumably, regulators will issue more-formal supervisory guidance before long.
Best Bet As long as the national economy continues to move ahead nicely, pulling most local economies with it, current house price booms should settle down quietly. Regulatory guidance on mortgage lending practices, along with home builder efforts to limit investor/speculator purchases, should help achieve that outcome.
Chief Economist, NAHB, Washington, D.C.