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Old 04-09-2012, 08:56 PM
RE Investor RE Investor is offline
Join Date: Apr 2012
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Thumbs up Why the `bubble' will burst

This story was the second of a five-part News series about the housing "bubble" debate. Part two details the arguments that support the 'bubbleists' predictions of a looming market collapse.

In the 1980s, home sellers in Manhattan had to slash their asking prices by 20 percent and bring money to the closing table to pay their way out of their mortgages.

"It was very difficult. We were having to call sellers every week and report that their property had had no activity--not even a look," said Susan, who owned a Manhattan-area boutique realty firm at the time. Shen recalled that property values declined as much as 40 percent in some of the city's "fringe" areas.

A weak economy and excess supply of housing triggered an outright housing market collapse in some parts of the country. Too many homes were for sale and not enough buyers were in the market. The result was plummeting home prices and skyrocketing delinquencies and foreclosures.

Homeowners in Oklahoma, Texas and Louisiana--states stung by the collapse in oil prices--walked away from their homes or signed deeds-in-lieu that gave their homes to the lenders to avoid foreclosure.

In Southern California homes were selling at a crawl. The once-robust housing market in the southern half of the Golden State was so soft in the first quarter of 1994 that 54 percent of the homes sold in prosperous Orange County fetched less than the price the seller had paid to purchase the home.

Back then, there was also the issue of short sales, where lenders were letting troubled homeowners sell the property for less than the mortgage balance. Lenders were quite non-communicative about that process.

Is the housing market today headed for a similar collapse?

Housing market bears pointed to a number of factors that suggest an affirmative answer to that oh-so-compelling question. They said increases in house prices have outpaced both household earnings and inflation, interest rates inevitably will go up and loose mortgage underwriting standards have saddled households with worrisome amounts of debt.

Bears also point to anecdotal evidence of a leak in the bubble with home prices cooling in some localized housing markets. A recent USA Today survey found housing prices have leveled off or even declined in some markets.

The most compelling argument put forward by those predicting a burst bubble is the widening mismatch between household incomes and house prices.

Prices nationwide have outdistanced homeowner income growth for several years, but the effects of the growing gap have been masked by falling mortgage interest rates, according to a report from Harvard University's Joint Center for Housing Studies. The report concluded a "moderate" rise in interest rates would "expose major affordability problems in some markets."

"I certainly don't believe double-digit (home price) appreciation can be sustained or even ought to be sustained over the near term," said economist. "At some point there does have to be a correlation between price growth and income growth."

The numbers that compare home price appreciate to inflation are stunning. A report released by the Center for Economic and Policy Research stated: "...over the past seven years, home prices have increased nearly 30 percent more than the overall rate of inflation."

Researcher and report author Dean Baker wrote that rising home price appreciation has increased housing wealth by more than $2.6 trillion--an average of $36,000 for each of the country's 73.3 million homeowners.

"There is no obvious explanation for a sudden increase in the relative demand for housing which could explain the price rise," Baker wrote. "In the absence of any other credible theory, the plausible explanation for the sudden surge in home prices is the existence of a housing bubble."

The conclusion is that stability in today's housing market is dependent on low mortgages interest rates. But no one can predict the direction of interest rates, which now are at 40-year lows.

Housing bulls suggest the market will remain healthy because of relentless demand from immigrants and new household formations. But cynics say that argument is faulty too.

Economist A. Gary Shilling, president of economic consulting firm A. Gary Shilling & Co., said Baby Boomers can't be expected to sustain a healthy demand for housing.

"Post-war babies are in their '40s and '50s and they're basically all housed. The people who follow them are very few in number because of the very low birthrate," he said. He also noted that Boomers have lost a lot of wealth in the stock market collapse and consequently might be more prudent in their purchases of vacation and second homes.

"They thought they were rich, and now they realize they're not," he said.

The bears also point out that higher housing affordability hurdles, which have the biggest impact on first- time and immigrant homes buyers, will dry up demand for more housing by pricing more people out of the housing market.

In California, to take one example, the median home price in July was $323,700, according to the California Association of Realtors. But only 28 percent of Californians earned enough income to afford that median-priced home.

The pin that could prick the housing market bubble--if there is one--could be loose mortgage underwriting, according to Shilling, who said the trigger could be a renewed recession, which he believes is a few months away.

Shilling offers this television-happy picture to illustrate his theory: Ralph Cramden obtains a no-down payment, low-interest-rate home mortgage that enables him and Alice to move out of their tiny apartment and buy Al Bundy's tract house. Bundy, in turn, trades up and buys Mike Brady's larger house in the suburbs. The Bradys move into a McMansion.

"Joe Six-Pack gets a very low down payment loan and he doesn't have a lot of other assets," said Shilling. "He creates a demand for housing and as long as he has a job he can meet his monthly payments. But if he loses his job in a renewed wave of layoffs or a second recessional phase, he's in trouble and that ripples up."

Harvard's 2002 study, "State of the Nation's Housing," also supports this scenario.

"Innovative financing alternatives have undoubtedly enabled many low-wealth and low-income families to become homeowners who would have otherwise failed to qualify for a loan....A prolonged economic downturn could be devastating to those households with a limited ability to meet their current mortgage payments and equally limited equity or cash reserves to ride out the storm," the study stated.

Also worrisome to some economists is the amount of debt homeowners acquired during the housing boom. Some 7 million homeowners refinanced existing mortgages last year and more than half of them took out a total of $80 billion cash in the process, according the Harvard study and Fannie Mae.

"The collapse of the housing bubble will lead to a loss of between $1.3 trillion and $2.6 trillion of housing wealth," wrote Baker. "This collapse will slow the economy both by derailing housing construction and by its impact on consumption through the wealth effect. In addition, millions of families are likely to face severe strains in their personal finances."
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