Real Estate Bubble OR NOT?

The housing industry has replaced the auto industry as the driving force in the U.S. economy. Bureau of Labor Statistics data compiled for me by Diana Furchtgott-Roth, a colleague at the Hudson Institute, show that the housing and related industries now account for 4.8 million jobs, some 60 percent more than the once-mighty auto industry. Whereas the auto industry has desperately shed 60,000 jobs in the past 4 years so as to reduce its future pension and health care costs, points out Furchtgott-Roth, the housing industry has created almost 600,000 jobs in the construction and financial services.

In one sense, the industry consists of a series of very local markets. As any prospective home buyer knows, the street on which a house is located, much less the neighborhood or the town, can importantly affect the value of that house. So when Federal Reserve Board chairman Alan Greenspan says that there is "froth" on some markets, he is careful to point out that we have never had a nationwide collapse in home prices, at least not since the Great Depression.

Indeed, the housing industry is no longer insulated from the globalization trends that characterize other markets. Investors from Germany to Abu Dhabi to China to Australia (our friends from Down Under have replaced Germany as the leading investors in U.S. commercial real estate) are pouring money into mortgage-backed securities, providing lenders here with still more money to lend to prospective home buyers, many of whom have substandard credit ratings. Meanwhile, proof that housing markets around the world are connected by the common forces of interest rates and job growth can be seen by looking at prices around the world. The Economist reports that the 13.0 percent rise in prices in the United States between the third quarters of 2003 and 2004 was topped by increases in Spain (17.2 percent), New Zealand (16.4 percent), France (14.7 percent), and Britain (13.8 percent).

In America, rising rates will almost certainly take some of the froth off the housing boom in some markets. Buy-and-flip investors, whose purchases "seem to have charged some regional markets with speculative fervor," to quote Greenspan, are likely to begin to unload properties bought when "up" seemed the only direction in which prices might move. And the use of what the Fed chairman calls "interest-only loans and ... more-exotic forms of adjustable-rate mortgages ... may leave some mortgagors vulnerable to adverse events" when some $1 trillion of the nation's mortgage debt--12 percent of the total--switches to adjustable payments in 2007, up from $80 billion, or 1 percent, at present. Which is why the Chairman used his valedictory to his fellow central bankers, gathered in Jackson Hole last weekend, to include house prices among the "economic imbalances" that he fears might upend his successor.

After all, Goldman Sachs reports, "Relative to per-capita GDP, a typical home in San Francisco now costs much more than one in London."