Jubak's Journal
Recent articles:
• 5 ways to play currency swings, 6/8/2005
• Thank Europe for a stronger dollar, 6/7/2005
• Why Buffett is buying utilities, 6/3/2005
More...
| | Jubak's Journal
Why there is no housing bubble
The sky is not falling. Yes, home prices are sky-high, but we really don't have a housing bubble that is anywhere near bursting. Here's why.
By Jim Jubak
Housing bubble? What housing bubble?
With the 10-year U.S. Treasury bond yielding below 4% and 30-year mortgages available at 5.1%, there isnt a housing bubble
Mind you, I'm not saying that U.S. consumers don't have too much debt, or that the U.S. economy isn't dangerously dependent on the housing sector for growth, or that all the money sloshing around the globe isn't encouraging dangerous speculation.
But those are different problems from the one getting all the headline attention at the moment.
It's just that, for all the teeth-gnashing and pundit-moralizing, we really don't have a housing bubble that's anywhere near bursting. Current 10-year interest rates are just too low. And I certainly don't see interest rates rising enough in the next year or so to burst a bubble, either.
Mortgage money is cheap
Oh, I'll grant you that housing prices are high. They're at nosebleed levels in some areas of the country, and still they keep climbing. According to the Federal Reserve Bank of Boston, national median home prices have climbed at an annualized rate of 8.2% from the fourth quarter of 2001 to the fourth quarter of 2004.
But that doesn't begin to capture the climb in prices of the hottest local markets. In Manhattan, for example, where I live, the median price for sales that closed in May was 23% higher than in May 2004, according to Halstead Property, a New York real-estate broker. The average price, which may better capture the action at the top of the market, climbed 34% from May 2004 to $1.3 million. Mind you, we're talking condo and co-op apartments here -- no back yard, no pool, no two-car garage.
But let's look at those prices adjusted for today's mortgage rates. The interest rate on a 30-year fixed mortgage is set by the yield on the 10-year Treasury bond. Right now, with the 10-year bond yielding an amazingly low 3.9%, you can easily find a 30-year mortgage for 5.1% in New York City (or Los Angeles or Miami, for that matter). (If you don't believe me, just check out MSN Moneys Essential homebuying guide.) The national average, right now, is 5.6% on a 30-year fixed mortgage.
A year ago, in June 2004, the 10-year Treasury yielded 5.2%. The average 30-year fixed mortgage, according to the Federal Reserve, carried an interest rate of 6.3%.
Related news and commentary on MSN Money
Look at what the shift in the average interest rate for a 30-year fixed mortgage does to a home buyer's monthly payment. At today's average of 5.6%, borrowing $500,000 results in a monthly payment of $2,870. A year ago, a home buyer would have paid about the same each month, $2,847 to be exact, on a loan of $460,000. Lower average interest rates have given a home buyer a boost of about 8.7% in buying power over the last year. That's remarkably similar to the 8.2% annualized increase in the median price of a home that the Boston Federal Reserve found.
Think of it this way: cheaper money made it possible to pay 8.7% more for a house in 2005 without taking an extra dollar out of the home-buyer's pocket in monthly mortgage payments.
Economics 101
What we're seeing in the housing market is monetary inflation. Pure and simple. Economic theory says that when more money chases a limited quantity of goods, the price of those goods increases. So nationally, cheaper money drives up the price of houses -- which does lead home builders to increase supply at higher prices. In areas where adding supply is harder -- the land for building a large number of apartments in Manhattan is scarce, as is land to build in Silicon Valley, on the Miami waterfront or in the core of San Francisco, to name a few other super-hot real estate markets -- new supply is extremely constrained at any price and prices for existing housing soars as a consequence.
Of course, this is all an extreme generalization. Adjustable and interest-only mortgages, as they become a bigger part of the mix, increase the supply of cheap money and drive up prices even faster, for example. Demographic trends increase prices faster than average in areas with more jobs, for example, or where cheap land lets builders construct new housing for the country's growing population of retired (or semiretired) workers.
But you get the idea: cheap money drives up housing prices.
Reverse the process and you get the logic of bursting bubbles. If interest rates rise, putting an end to the supply of cheap money, prices will fall. If the fall in prices gathers enough speed, the bubble will not simply gradually deflate but, instead, pop all at once.
Based on past history, at least, a modest rise in mortgage rates won't do the trick. Average interest rates for a 30-year fixed mortgage rose to 6.3% in May 2004 from 5.5% in May 2003 without sending housing prices sliding quickly lower. Based on the projections from the National Association of Home Builders, a future climb in mortgage rates from 5.8% in 2004 to 6.6% in 2006 wouldn't have a huge effect on sales of either new or existing homes. As mortgage rates climbed 0.8 percentage points, new-home sales would fall by 6.5% from 2004 to 2006, and sales of existing homes would decline by 5%. At worst, that's air gently escaping from any housing bubble.
And if you want a glimpse of what today's lower rates might do to the housing market if they're sustained for a year, take a look at the projections released by the National Association of Realtors on June 8. The group's economists now expect existing-home sales to climb 3% from 2004 and new-home sales to rise 2%. Total home sales will hit a record 8.13 million in 2005, up 2% from 2004, thanks to the current low mortgage rates. Back in February, when it looked like mortgage rates would go higher instead of lower, the group projected a 2% decline in existing-home sales in 2005 and a 6% drop in new-home sales.
|
