Housing - What Me Worry? by Nicolas P. Retsinas

Housing: What Me Worry?

by Nicolas P. Retsinas
January 11, 2003
The Providence Journal

Nationwide, homeowners view the escalation in housing values with a mixture of joy, relief, and dread.

The joy comes from the accumulation of wealth. Last year seven million households used their homes as ATM machines. Refinancing is easy as some new owners refinance every six months, taking advantage of ever-lower interest rates. The average monthly savings: $100. And over half took out extra money, cashing in on the increase in value. In total, Americans withdrew $88 billion from their homes last year.

The relief comes from the almost-meteoric rise-and-fall of the other venues for investment: the stock and bond markets. Much of the recent Dow Jones surge proved to be a bubble. Investors who watched their 401ks plummet have looked on their homes as good investments. Even people who do not own stocks looked with relief on their houses: for the last seven years, home price appreciation has outpaced inflation.

But that relief is tinged with dread: What if housing too proves to be a bubble, and like all economic bubbles, from dot.coms to tulips, bursts? Even while reveling in their good fortune, owners feel under a sword of Damocles, as they wait for the inevitable downturn.

We are a nation of exuberant, yet fearful, homeowners.

Rhode Island homeowners have been especially jubilant: over the past five years, home prices increased 55 percent (from 1980, prices increased 285 percent). That same period, the median home price rose from $166,000 to $199,950. Yet even while homeowners have racked up gains, at the same time they have racked up their quotient of dread, as they wait for this sword to fall, this bubble to burst. The more rapid the rise in values, the more profound the sense of dread.

The standard economic truisms have fueled the dread: Escalation cannot continue. What goes up must come down. The rise in housing prices must eventually jibe with the rise in incomes (which have not risen by double-digits over the past five years). If stocks plummeted, so will housing.

Yet home purchases reached another record - over six million - in 2002. And people keep buying.

Owners, though, worry: Is housing a bubble? Is this nagging dread rational?
Housing is not a tulip, a dot.com, or an Enron-type megalith. It is a concrete product, a bricks-and-mortar home for real people. People buy houses to live in them, not primarily as investments.

This commodity, moreover, is not easily fungible. As anybody who has sold or bought a house can attest, the transaction costs, in money and time, are high. You can unload 1000 shares of Enron at the click of a few computer buttons; it takes months to sell a house.

Most importantly, though, the demand for this commodity outstrips supply.
The reasons for strong demand are several.

First is population. We are a growing nation, adding over six million net new households over the past five years. Immigration has skewed the demand- supply imbalance; but even if we closed our gates, household growth will remain robust as recent arrivals form more and more households.

Low interest rates make home ownership both affordable and rational. Renters who do the math often decide to buy a house as soon as they can muster a downpayment.
And the threshold for downpayments has dropped to less than 5 percent. In the 1980s the standard downpayment was 20-25 percent.

Government subsidies have bolstered demand, encouraging low-income Americans to buy their first-homes.

Our mortgage system is efficient, offering not just cheaper loans, with lower downpayments, but a hodgepodge of products, designed to accommodate a range of buyers.

Finally, housing has emerged as an alternative to a volatile stock market. Investors who fear that their money may evaporate on Wall Street are buying second, if not third, homes hoping to tangibly enjoy this investment.

The rise in housing values, in short, is built on some solid foundations.

That is not to say that prices are destined to soar ever higher, until we all own million-dollar split-levels. Even the most sanguine analysts expect the current price escalation to abate. The economic axiom is right: eventually prices must jibe with income. In selected markets, analysts have already noted small decreases in value.

A steep rise in unemployment would dampen demand. The renter who expects a pink slip is not about to house-hunt. In fact, we may have entered a period of renter-caution, marked by the recent implosion of the manufactured housing industry, coupled with escalating vacancy rates in luxury rental apartments. (A rise in unemployment will also force more owners into delinquencies and foreclosures, since many have borrowed so heavily on their equity that their financial cushion is meager).

Even with continued high employment, a rise in interest rates would slash demand. Many buyers who could afford a mortgage at today's rates of under six percent could not afford one at eight percent.

The Cassandras who speak of housing as a bubble, liable to burst anytime soon, have alarmed the two-thirds of American households who own their own homes. Let the Cassandras pause. At least at this moment in time, homeowners' exuberance is rational.