Housing Boom Continues
June 24, 2002
by Irwin Stelzer
Dinner parties in Britain and America have one thing in common: house prices dominate the conversation. Those who own, gloat; those who don’t, moan. But the gloaters also worry that they are about to witness the house-price version of the dot-com bubble. And the moaners console themselves with old clichés: “if it’s too good to be true, it isn’t,” or, “no tree grows to the sky.” Meanwhile, the owner-gloaters stifle their fears and extract the new, higher equity by raising their mortgages—“mortgaging out,” in American parlance.
Last year alone Americans pulled $90 billion in cash out of their homes via higher mortgages, and some tens of billions more through home-equity loans. This has helped to fuel consumer spending, which in turn kept the economy from falling into recession until the recent restocking began. The house price increases have also made it profitable for builders to accelerate construction of new homes: house building in the first five months of this year was at its highest level in almost 25 years.
Good news, indeed, for manufacturers of everything from the sitting-room sofa to the kitchen sink. Home building and spending on household goods account for almost 9 percent of the U.S. economy. That’s a significant portion: government spending and business investment in information technology each account for only about 6 percent.
In order to understand just what is going on in the U.S. housing market, and to make an educated guess as to what is likely to happen in the future, it is important to look behind the headline figures on house prices. The National Association of Realtors (NAR) reports that the median price for single-family homes jumped 7.1 percent in the year ending April 30. Two things to keep in mind. First, the most recent increase is not very far out of line with the 6.3 percent annual average increase the NAR reports for the past three decades. Second, part of the increase in the average price merely reflects the fact that the average house being sold is larger than ever, so that buyers are getting more for their money.
Still, there is no denying that the market is buoyant, witness numerous reports of buyers making offers in excess of the asking price in order to be certain that their dream of home ownership is realized. One reason that U.S. house prices keep rising is that in the U.S., as in the UK, interest rates are low, making it cheaper to borrow and buy. Another is that share prices are, to put it kindly, in the doldrums, making property a relatively more attractive investment than equities.
Then there is demography, which in the case of the housing market surely is destiny. Just when the Baby Boomers entered what analysts call their peak home-owning years, the flood of immigrants who reached America’s shores (or walked across its border with Mexico) in the 1980s moved sufficiently up the economic ladder to be able to afford their first homes. To accommodate them, government lending agencies lowered required down payments from the usual 10 to 20 percent, to a mere 3 percent. Throw in low interest rates, and houses become affordable.
And remain so, as rising disposable incomes keep pace with rising prices. Business Week estimates that the median sale price of existing single-family homes has risen 18 percent since 1996, adjusting for inflation. During that same period, real wage and salary income per worker rose by an almost identical amount, 16 percent.
Adding to the demand that is driving up house prices and keeping construction crews busy is a vibrant second-home market. With property seeming to be a better long-term investment than shares, aging Baby Boomers with extra cash are putting it into vacation homes. Some observers relate this to a post-September 11 desire to vacation nearer to home—only a tank full of gasoline away—rather than fly to more exotic destinations. Others say that as Baby Boomers begin to give serious consideration to the calendar, they are looking to acquire properties to which they might retire, eventually selling their principal residence and availing themselves of the capital gains tax relief built into the tax for retirees with homes to sell.
All of which leaves two questions: is the housing market a bubble about to burst, as the bricks and mortar business emulates the NASDAQ? And, what should the monetary authorities do about it?
The consensus answers are “no” and “nothing.” The home ownership rate for people under 35 is only 41 percent, compared with an overall rate of 68 percent. So there are a lot of younger people out there eager to realize the American dream of home ownership. The economy is recovering, which should keep incomes moving up, but share prices are not, which should continue to make property a relatively attractive investment.
Most important, there is little prospect of a major rise in interest rates. At least until the Federal Reserve Board’s monetary authorities are convinced that the economic recovery is on firm footing, they are unlikely to raise rates, and very unlikely to raise them by very much.
Nor will the Fed be tempted to raise rates merely to cool the housing market. Chairman Alan Greenspan made that clear when asked whether we are witnessing a dot.com-style bubble. He replied as clearly as a practiced central banker can, “Unlike stocks where you have a single market, low transactions costs, and an ability of people to pile on nationally and cumulatively, residential-housing markets are all local. Transactions costs are quite large. To unload your asset, usually you have to move.” That, he went on, “is an obvious impediment to stimulating a bubble through speculative trading in homes.” In plainer English, it is a lot harder to sell your home than it is to place a panicky sell order with your stock broker.
An easing of the rate of increase in house prices may be ahead, and even a period of stability. But don’t bother keeping an ear cocked for the sound of a bursting bubble. All you’re likely to hear is the sound of silence.
This article originally appeared in London's Sunday Times on June 23, and is reprinted with permission.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.