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THE ECONOMY
Is Housing the Next Bubble?
Sure, there's some pretty scary stuff going on. But things aren't as crazy as the last time the property market heated up. FORTUNEMonday, April 1, 2002 By Anna Bernasek
http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=206914
The signs of recovery are so obvious that only an Olympics figure-skating judge could miss them. The manufacturing sector rebounded in February after an 18-month-long tailspin. Activity in the all-important services sector has now accelerated to its fastest pace in more than a year. Productivity growth has just been revised up to 5.2% for the fourth quarter, a level that's causing 1990s flashbacks. And on the jobs front, employment grew for the first time in seven months. Even capital spending, a longtime trouble spot, seems to be reviving. In fact, the news has been so good that Alan Greenspan, our famously cautious, usually indecipherable Federal Reserve chief, recently proclaimed in plain English: "An economic expansion is already under way." So is that it? Have we just had something like a 15-minute recession, and is it all smooth sailing from here? Not so fast, says a chorus of economists--plenty can still go wrong. Leaving aside such nightmare scenarios as further terrorist attacks, all-out war in the Middle East, or an oil embargo, the thing that spooks some economists the most is housing. That's because while the economy has been on the down escalator over the past several months, the property market has been going in the opposite direction, and that's just not supposed to happen. In fact, housing didn't just hold its own during the slump. It zoomed. Activity has been so strong that sales of new and existing homes hit all-time records last year. Not exactly what you'd expect when around two million people were losing their jobs, is it? What's more, we've seen record growth in mortgage refinancing, and annual home-price increases between 6% and 8% nationally for three years in a row. "That's unsustainable by any measure,'' says David Levy, chairman of the Jerome Levy Forecasting Center. "Especially now that mortgage rates are on the rise." And that's the problem, according to Levy and others. The one sector we've relied on to keep the economy afloat is unlikely to hold up much longer. Worse still, housing could even turn out to be the next bubble--and we all know how that usually ends. So are the worrywarts right? Probably not, but it's certainly worth hearing them out, because even if they're a little right, a weak housing market could help make this recovery pretty darn anemic. There are already signs that housing activity is starting to cool. For the first time in seven years, national home prices fell in the last three months of 2001, by 1.9%. The market for second homes has also weakened since the end of last year. And some banks are tightening up on their mortgage lending. Ken Hackel, chief fixed-income strategist at Merrill Lynch, says one major bank has admitted to recently changing the rules on refinancing, requiring appraisals on every application regardless of whether one had been done in the past year--a telling sign that some lenders expect home values to soften. True, January sales remained incredibly strong, but economists argue that those numbers were probably exaggerated by the unseasonably warm winter across much of the nation. Certain regional markets may already be in trouble. According to data from Case Weiss Shiller, home prices in San Francisco have been dropping precipitously. In the first quarter of 2001 the average price of a single-family home there rose 4%, but by the end of the year had fallen 7%. "We're seeing a bubble bursting right now in San Francisco," says Robert Shiller, an economics professor at Yale University and partner at Case Weiss Shiller. "We've never seen such a sharp drop, and we're expecting it to fall even more." Shiller, who warned of a stock market bubble in the late 1990s and coined the phrase "irrational exuberance," believes there's the risk of a housing bubble in other major cities. At the top of his watch list are Portland, Ore., Seattle, Denver, and New York. If you thought the tech bubble's bursting was bad for the economy, just imagine what a housing bubble could do. Around two-thirds of households own their home, while only half have exposure to the stock market. That means the wealth effect we heard so much about during the 1990s is even more pronounced when it comes to housing--in fact, according to a study by Shiller and a colleague, it's twice as large. A 10% increase in home values, for instance, would result in a 0.6% increase in consumption, they found, while a 10% increase in stock prices would lead to a 0.3% increase in spending. "People see their home as a source of wealth," says Shiller, "so they haven't felt the need to save. That's sustained our high level of consumption, but it's made the economy more vulnerable." How did we get here? Simple: Interest rates on 30-year mortgages have fallen from a peak of 8.7% in May 2000 to a low of 6.5% in November 2001. That sharp drop encouraged a record wave of refinancing even as the economy slowed down. Douglas Duncan, chief economist at the Mortgage Bankers Association, calculates that so far households have taken out at least $80 billion in equity after refinancing their mortgages. From that total, he estimates $50 billion has been spent and $30 billion used to pay off debt. It's that extra $50 billion in consumer spending that has kept the economy from sinking further in this downturn. (To put that number in perspective, $50 billion is about the same size as President Bush's 2001 income-tax cut.)
Is Housing the Next Bubble?
Sure, there's some pretty scary stuff going on. But things aren't as crazy as the last time the property market heated up. FORTUNEMonday, April 1, 2002 By Anna Bernasek
http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=206914
The signs of recovery are so obvious that only an Olympics figure-skating judge could miss them. The manufacturing sector rebounded in February after an 18-month-long tailspin. Activity in the all-important services sector has now accelerated to its fastest pace in more than a year. Productivity growth has just been revised up to 5.2% for the fourth quarter, a level that's causing 1990s flashbacks. And on the jobs front, employment grew for the first time in seven months. Even capital spending, a longtime trouble spot, seems to be reviving. In fact, the news has been so good that Alan Greenspan, our famously cautious, usually indecipherable Federal Reserve chief, recently proclaimed in plain English: "An economic expansion is already under way." So is that it? Have we just had something like a 15-minute recession, and is it all smooth sailing from here? Not so fast, says a chorus of economists--plenty can still go wrong. Leaving aside such nightmare scenarios as further terrorist attacks, all-out war in the Middle East, or an oil embargo, the thing that spooks some economists the most is housing. That's because while the economy has been on the down escalator over the past several months, the property market has been going in the opposite direction, and that's just not supposed to happen. In fact, housing didn't just hold its own during the slump. It zoomed. Activity has been so strong that sales of new and existing homes hit all-time records last year. Not exactly what you'd expect when around two million people were losing their jobs, is it? What's more, we've seen record growth in mortgage refinancing, and annual home-price increases between 6% and 8% nationally for three years in a row. "That's unsustainable by any measure,'' says David Levy, chairman of the Jerome Levy Forecasting Center. "Especially now that mortgage rates are on the rise." And that's the problem, according to Levy and others. The one sector we've relied on to keep the economy afloat is unlikely to hold up much longer. Worse still, housing could even turn out to be the next bubble--and we all know how that usually ends. So are the worrywarts right? Probably not, but it's certainly worth hearing them out, because even if they're a little right, a weak housing market could help make this recovery pretty darn anemic. There are already signs that housing activity is starting to cool. For the first time in seven years, national home prices fell in the last three months of 2001, by 1.9%. The market for second homes has also weakened since the end of last year. And some banks are tightening up on their mortgage lending. Ken Hackel, chief fixed-income strategist at Merrill Lynch, says one major bank has admitted to recently changing the rules on refinancing, requiring appraisals on every application regardless of whether one had been done in the past year--a telling sign that some lenders expect home values to soften. True, January sales remained incredibly strong, but economists argue that those numbers were probably exaggerated by the unseasonably warm winter across much of the nation. Certain regional markets may already be in trouble. According to data from Case Weiss Shiller, home prices in San Francisco have been dropping precipitously. In the first quarter of 2001 the average price of a single-family home there rose 4%, but by the end of the year had fallen 7%. "We're seeing a bubble bursting right now in San Francisco," says Robert Shiller, an economics professor at Yale University and partner at Case Weiss Shiller. "We've never seen such a sharp drop, and we're expecting it to fall even more." Shiller, who warned of a stock market bubble in the late 1990s and coined the phrase "irrational exuberance," believes there's the risk of a housing bubble in other major cities. At the top of his watch list are Portland, Ore., Seattle, Denver, and New York. If you thought the tech bubble's bursting was bad for the economy, just imagine what a housing bubble could do. Around two-thirds of households own their home, while only half have exposure to the stock market. That means the wealth effect we heard so much about during the 1990s is even more pronounced when it comes to housing--in fact, according to a study by Shiller and a colleague, it's twice as large. A 10% increase in home values, for instance, would result in a 0.6% increase in consumption, they found, while a 10% increase in stock prices would lead to a 0.3% increase in spending. "People see their home as a source of wealth," says Shiller, "so they haven't felt the need to save. That's sustained our high level of consumption, but it's made the economy more vulnerable." How did we get here? Simple: Interest rates on 30-year mortgages have fallen from a peak of 8.7% in May 2000 to a low of 6.5% in November 2001. That sharp drop encouraged a record wave of refinancing even as the economy slowed down. Douglas Duncan, chief economist at the Mortgage Bankers Association, calculates that so far households have taken out at least $80 billion in equity after refinancing their mortgages. From that total, he estimates $50 billion has been spent and $30 billion used to pay off debt. It's that extra $50 billion in consumer spending that has kept the economy from sinking further in this downturn. (To put that number in perspective, $50 billion is about the same size as President Bush's 2001 income-tax cut.)
