A housing market that appears finally to be firing on all cylinders is increasing confidence in the strength and durability of the recovery, but it is also triggering fears that a new, potentially damaging price bubble may be forming.
Those fears stem largely from the steep increases in home prices recorded over the past several months. Both the 10-city and 20-city Case-Shiller home price indexes posted double-digit year-over-year gains in March – 10.3 percent and 10.9 percent, respectively. This represented the third consecutive robust increase for the larger index and its largest annual gain in more than 7 years.
Most view these positive numbers as a welcome change from the downward price spiral of the recent past, but the rapid price gains are creating an uncomfortable sense of déjà vu for some analysts, who fear a repeat of the home buying and home lending excesses that toppled the housing market and triggered the recession from which the economy has not yet fully recovered.
Out of Sync
The major fear is that rapid price gains will outpace the growth in jobs and incomes, which remains moderate, at best. Employers added 175,000 workers to their payrolls in May and average hourly earnings remained essentially flat. “It’s a decent report, but it’s not by any means robust,” Conrad DeQuadros, senior economist at RDQ Economics, told the New York Times.
The employment gains, by any measure, are less dramatic by far than the run-up in home prices, and that imbalance is cause for concern, Lawrence Yun, the chief economist for the National Association of Realtors (NAR), acknowledged. “Any time that happens over a sustained period it is an unhealthy state for the country," he observed at the NAR’s mid-year conference in May.
But the consensus view among industry analysts appears to be more sanguine. For one thing, they note, the easy credit standards that fueled the last bubble aren’t present today. If anything, housing industry executives complain, the problem is overly restrictive underwriting that is hampering the recovery.
An article in The Economist pointed out that in order to qualify as a bubble, “an asset must not simply appreciate; it must decouple from its intrinsic value.” And the publication’s analysis of the Case-Shiller data found no evidence that this is the case. “In most markets, houses are at or near their long-run values, but none looks bubbly,” the article concluded.
“Talk of a house price bubble seems premature,” Ed Stansfield, an economist at Capital Economics, agreed. “In relation to incomes, rents or their own past,” he told the New York Times, “U.S. home prices still look low.”
Speaking at the NAR’s housing conference, Jed Kolko, an economist at Trulia, echoed that view. “Prices would have to rise at the current rate for several years to return to bubble territory,” he suggested.
A Virtuous Circle
The strongest argument against bubble risks, other analysts contend, is that the price increases we’ve been seeing simply aren’t sustainable. Rising prices are encouraging reluctant sellers to list their homes, allowing more previously underwater owners to do so, and persuading builders to increase the production of new homes, easing the inventory shortages that have produced much, if not all, of the upward pressure on home prices and creating what economists term “a virtuous circle”: Moderating price pressures will keep affordability levels high, increasing buyer demand, encouraging more new construction and creating a healthier market, more evenly balanced between buyers and sellers.
CoreLogic predicts that average appreciation rates will slow to a more sustainable 3 percent to 4 percent, closer to the long-term average, over the next two years. Mortgage rates, already beginning to creep up from their near historic lows, will keep demand from overheating, creating another anti-bubble force, analysts say.
For the moment, Federal Reserve Chairman Ben Bernanke is trying to thread a monetary policy needle, emphasizing the Fed’s willingness to end the “quantitative easing” that has kept rates low, while reassuring a nervous housing industry that the economy generally and the labor market in particular must be stronger before the Fed makes that move.
When Interest Rates Rise….
But the Fed will eventually remove the restraints that have been holding rates down, raising the obvious question: Will rising rates curtail buyer demand and short-circuit the housing recovery?
Goldman Sachs economists Hui Shan and Marty Young addressed that question in a recent research note, and concluded that there is little cause for concern. What matters most, they said, is not that rates are rising, but the reason why. And in their view, rates are increasing for the right reason – because the economy is improving. A strengthening economy will stimulate growth in jobs, income and confidence, which in turn will bolster the housing market and offset the negative impact of higher rates, these analysts contend.
In a blog discussing the Goldman analysis, Washington Post columnist Neil Irwin concludes: “As long as home prices remain below the level where affordability is out of reach, and so long as mortgage rates are rising because the economy is on the mend, the housing market should be able to withstand the blow.”
Notwithstanding his concerns about the potential for a home price bubble, the NAR’s Yun also thinks conditions favor a “multi-year housing recovery” fueled by pent-up demand, a lag in housing starts, and an improving economy that itself will be buoyed in part by the strengthening housing market. He predicts that rising home values will increase household wealth by more than $2 trillion over the next two years.
LaVaughn Henry, vice president and senior regional officer at the Federal Reserve Bank of Cleveland, shares that optimistic view. Speaking on a panel with Yun at the NAR’s mid-year conference, Henry said, “We are in a solid, sustainable recovery, [characterized] by an alignment of the fundamentals [that] make housing work.”
Room for Doubt
While the chorus of voices cheering the housing recovery has grown louder, it has not entirely drowned out the skeptics, who see plenty of reasons to question the recovery’s strength and durability. A recent article in DS News identified several trends that, some analysts think, should give the optimists pause:
- In a recovery, sales and prices should both be increasing, but in 7 of the 12 months last year, they moved in opposite directions.
- Mortgage origination totals were higher in the first quarter of this year than in the fourth quarter of 2012, but lower than in the second and third quarters of last year.
- Buyer traffic reported by home builders was higher in May than in April but weaker in the first quarter of this year than in the fourth quarter of last year.
- Housing starts have increased significantly in recent months, but most of the gains have been concentrated in the multi-family sector.
- There is no question that a housing recovery “is critical to a recovery of the economy as a whole,” the DS News article concludes, “but wishing won’t necessarily make it so.”