Froth
Clay Risen, channelling the Harvard Joint Center for Housing Studies, makes an argument I don't really understand:
The JCHS study affirms Fed Chairman Alan Greenspan's recent statement that while there is reason for concern about rising housing prices, what looks like a bubble in some areas is really just localized froth. True, home prices have "outpaced per capita income gains by more than 4 times in 31 metros, 3-4 times in 19 metros, and 2-3 times in 32 metros," according to the report, but outside those areas (which account for about a quarter of the population) appreciation has remained relatively close to per capita income gains.
Isn't 25 percent of the population rather a lot? If metro areas containing one American in four were suffering from persistent brown-outs, I don't think we'd dismiss that as "just local power outages." And consider that the metro areas in question contain more than a quarter of the nation's total income and significantly more than a quarter of the nation's total home equity. On top of that, in the other seventy-five percent of the country, appreciation has exceeded per capita income gains somewhat.
That aside, the actual point of the article -- that the housing boom isn't all sweetness and light for the non-trivial portion of the population that doesn't own a home -- is welcome. This is part of the problem with basing your economic strength on housing appreciation -- it's not just an investment commodity, people also need to live somewhere. High stock prices don't, as such, hurt the interests of people who don't own any stocks. Housing isn't like that.
I don't subscribe, so I can't read the article. But I sure hope he explains why he apparently thinks that the primary sign of a housing bubble is where "home prices have outpaced per capita income gains". That seems just completely wrong to me, since supply and demand of houses would seem to have little to do with supply and demand of labor.
June 14, 2005 7:57 AM | Reply | Permalink
I'm not an expert on this, but it seems to me that you can't just average the numbers and conclude that all is well since the average is not in bubble territory. Those people in the bubbly quarter are not going to do much to arbitrage (up or down) housing prices by investing in the other three quarters. Are NY finance people supposed to move to Terre Haute? Or sell their coops, rent in NY, and buy in Terre Haute? Not so easy. So the potential for a relatively fast deflation remains. And having felt the wealth effect on the way up, and they'd feel it on the way down, too, which is what economic gurus are supposed to worry about, right?
June 14, 2005 8:31 AM | Reply | Permalink
Agreed. Long Term Capital Management (sic) was a small part of the overall financial system, but they managed to do damage tremendously out of proportion to their size. The same thing is true of the East Coast and LA housing markets: (smaller number of houses) * (vastly higher prices) = large percentage of total mortgage market.
sPh
June 14, 2005 8:38 AM | Reply | Permalink
Al (are you really Al? i thought the one and only real Al worked in some finance-related endeavor), the issue with per cap incomes is that it drives what people can "afford" in terms of monthly mortgage (based on long-term norms). Obviously, it's not imposible to spend 50% of your monthly income on a mortgage if you have no interest in cable tv, new clothes, eating anything other than rice and beans, and so forth (or if you're extremely wealthy or blessed with a very high income), but for most people, spending more than 25 - 30% of their income on a mortgage is very iffy.
so if house prices (well, let me phrase that more carefully: if the monthly mortgage nut) is increasing much faster than incomes, there is trouble ahead. indeed, the popularity of interest-only mortgages is a clear indicator of the reality of that potential problem. Now, were we starting off a base where housing prices were depressed and had been for a while, to the point where monthly mortgages were only running 10 - 15% of income, then there's plenty of room for prices to rise faster than incomes without it becoming a problem.
but by and large, that's not what we have, hence the warning signal.
June 14, 2005 9:27 AM | Reply | Permalink
The argument Greenspan is making is fairly clear; “it’s not my problem.” A nation-wide bubble is a macro-economic phenomenon; it is of concern to the Fed. A bubble in a particular area, that is not affecting other areas, is a micro-economic phenomenon; it isn’t something the Fed worries about.
June 14, 2005 10:13 AM | Reply | Permalink
Al, I'm no expert, but you have to have the income to pay the mortgage, right?.
June 14, 2005 12:05 PM | Reply | Permalink
Howard (and janeboatler), while I don't think that incomes and housing prices are completely unrelated, I don't see that there should be a direct correlation between the two.
To take howard's objection: "the issue with per cap incomes is that it drives what people can 'afford' in terms of monthly mortgage". But there are obviously other factors driving how much of a mortgage people can 'afford', such as, for example, interest rates, types of mortgages banks will extend (more interest-only mortgages, more 'affordability'), and perceptions about the economy (the better people perceive the economy, the more likely the may be to take out a larger loan). So if my income goes up by only 3%, but interest rates decline, I can now get an interest-only loan, and I think the economy is good so I don't have to worry about losing my job and I think I'm likely to get a raise, then how much more of a house can I 'afford'?
In addition, you are only looking at one side of the housing price equation. If people can afford a bit more of a mortgage, does that automatically mean housing prices will go up? What if two areas have similar increases in per capita income, but in one area there is a ton of new construction, but in another there is no new construction. Effect on housing prices?
June 14, 2005 2:41 PM | Reply | Permalink
Two considerations deserve more attention that Greenspan provided in his Joint Economic Committee testimony last week.
1. The percentage of interest-only mortgages of total mortgages issued since 2003.
2. The percentage of variable interest rate mortgages of total mortgages issued since 2003.
MSNBC's 'The Home Loans Vexing Greenspan', http://msnbc.msn.com/id/8170397/ , highlights the percentage of interest-only mortgage loans during 2004. The percentages have risen substantially since then.
Governor Susan Schmidt Bies, Federal Reserve, http://www.federalreserve.gov/boarddocs/speeches/2005/20050614/de fault.htm, today stated that variable interest rate mortgage loans (AMRs) "have grown substantially and now account for more than a third of all mortgage originations, the highest level since 1994."
Anyone dismissing these two considerations doesn't understand the potential impact of a 2% rise in mortgage rates. This doesn't include the potential problems with the large number of equity loans that have been taken out by households.
June 14, 2005 3:40 PM | Reply | Permalink
Matt, there was a time when an important post like this would have 100 comments. I hate this format, and the type is to small to see when making a comment.
June 14, 2005 5:08 PM | Reply | Permalink
Matt has a forceful closing point here (see the plight of the little rental people!) but unfortunately it's not really correct. In two different senses, rentees aren't suffering much due to the housing bubble/froth (bubbth? frooble?). At least, not yet.
Item Two: In areas where rental prices have gone up, it's primarily the cost of house rentals that have gone up, a relatively small fraction of the rental market. Apartments in my mildly-frothy town (Austin, Texas) have struggled to fill occupancy, especially the glut of high-end apartments built since the mid-nineties. Their target market, alas, either got pink-slipped in the dot-com bust or have since bought new houses. So these upscale apartments have cut back some on their rent to attract more rentees (mostly well-to-do sorority girls, from what real estate agents tell me). And I personally know that low-cost apartment housing has remained low-cost, across the board. I can't find the link, but I've heard Brad talk about a similar rental squeeze in CA.Item One: Rentees in frothy locales aren't in fact paying much more for their rent these days. From General Glut, as per Brad DeLong, here's the moneyshot:
But I don't want to be a total contrarian. It's a truism: when a market decline hits the worst-off are hit the hardest. Everybody else finds a way to pass them the hot potato. I'm not equipped to make a rigorous argument, but I betcha if/when the housing bubble hits, locally or nationally, rentees take a pounding.
So Matt's emphasis is morally correct, if not factually so.
June 14, 2005 5:51 PM | Reply | Permalink
Al, in terms of the first issue (type of mortgage), look again at my second paragraph. i'm aware of that issue and don't discount it. That's also why i put "afford" in quotes.
In terms of the second issue, yes, the three most important rules in real estate are location, location, location. We have a bunch of little real estate markets, not one big one. Supply and demand factors are different in each locale. But broadly speaking, housing prices that are jumping up faster than is people's capacity to pay eventually are going to be unsustainable. It's as good a link as you can ask for. (I mean, i even hedged this very point by noting that it was entirely possible for a period of time for prices to go up faster than incomes, if prices started from a low level.)
June 14, 2005 6:19 PM | Reply | Permalink
What no one mentions about the froth, is where that extra equity comes from! Money doesn't fall off trees, when your condo goes up 200k in value that money comes from somewhere. Guess where it comes from? It comes from people like Matt, and I working 10 years longer to pay off the mortgage. In a sense this is a transfer from young workers to older property owners.
I see 2 possiblities. 1) this is sustainable, the economics of work, less likely to keep jobs for more than a few years, has made living outside a major city untennable for the well educated and nearly wealthy like myself. This means the premium we pay to live in SF Bos WAsh or NYC is worth it, and property values will last through economic any speed bumps.
2) there will be a major rebalancing, starting with a Yan reVal, and all the debt American hold through their government and personally through mortages and credit cards will really hit home. It will be like 91 when houses in Astoria queens went from 500k to 300k, and only now have recovered those values. (This only happens if the rest of the world slows, so that they stop sending money to America and subsidizing our interest rates)
June 14, 2005 6:33 PM | Reply | Permalink
The apostles of perpetual boom are back! Sure hope they sold their shares of pets.com before the crash.
June 14, 2005 8:50 PM | Reply | Permalink
It would seem to bear mentioning that this thing may be more like the blob than the froth, spreading from metro areas and infecting outlying regions as well. A relative of mine lives in Nevada County, California, which is in the Sierra Foothills, several hours east of San Francisco. Property values there have gone loco in the past three years or so, and it isn't commuters from Sacramento largely buying the homes but overwhelmingly speculators from San Francisco, Marin, Silicon Valley, and LA driving the prices into the stratosphere. Most have no intention of living in the properties, and are pricing out very, very frustrated and angry local people trying to afford a home (there's no way a huge percentage of people - especially young people - who live and work in that county could afford the prices homes are now fetching there). The same seems to be happening in outlying rural areas north and south of San Francisco, and outside other metro areas as well.
June 15, 2005 9:38 AM | Reply | Permalink
Also, while it might be fine for conservatives and backlash liberals to suggest that the political opinions of the liberal blue zones (which happen to be where a great deal of this "froth" has accumulated) don't matter, it's a quite something else to suggest that these regions don't matter economically. They are to no small extent where the wealth and jobs and tax revenues in this country are being generated, and a rapid devaluaton of housing prices in the blue zone can't be good for the wider economy.
June 15, 2005 9:49 AM | Reply | Permalink
All this talk of per capita income v the cost of housing in some sense half misses the point here, which is as the post above suggests that a good part of the appreciation is now being driven by speculators looking for somewhere allegedly safer to put their money than equities. It is one of the chief symptoms of a bubble, and it is unsustainable.
June 15, 2005 1:22 PM | Reply | Permalink