Pause a moment in your busy life of shopping and spending to take a brief stroll around the investment that is making your lifestyle possible.
As you inspect your doors and floors, see if you can find the reason why the price of your home is twice what it was three years ago.
Has California had another Gold Rush bringing countless new residents with bundles of cash to your community? No, that isn’t it. Growth in jobs and incomes and residents has been tepid compared with the decade of the 1990s.
Has the state imposed new barriers that will make it more expensive to build new homes as the state’s population grows? No, that isn’t it. Zoning restrictions and an onerous permitting process were firmly in place three years ago, and, moreover, building rates nationally have more than kept pace with the growth in the adult population.
Was there a beetle infestation that destroyed the softwood forests of North America, giving the framing in your house some extraordinary new scarcity value? Not that I heard about.
It’s finance, first and foremost. What’s different now is that the 10-year Treasury is yielding under 4 percent and banks are offering zero-down, interest-only, floating-rate, negative amortization loans with teaser rates promoted over the Internet, alongside Viagra and business opportunities with shady fellows from Nigeria.
It’s also momentum investing. When the equities markets delivered astonishing returns in 1998 and 1999 there were plenty of New Economy Hucksters who convinced many investors that 20 percent per year was normal.
Now that the anxiety level of prospective homebuyers is at an all-time high, there are ample real estate hucksters who promise that the price of a California home can never go down. But anyone who has been in the residential real estate sector in California for more than a decade and anyone who has taken a close look at the state and national housing data surely realizes that residential real estate is an up and down business.
It is impossible to predict the exact month that the peak will occur, but it is nonetheless wise to look at the historical data for markers. The hottest final months of housing expansions are characterized by low levels of inventories of homes listed for sale, high levels of building and high prices and unsustainable appreciation rates. Like now, baby.
The decline in affordability could soon overwhelm the ingenuity of lenders to qualify buyers. A clear whiff of inflation could send interest rates quickly up and kill off the housing sector. Rates would also rise if the Asian central banks stopped buying Treasury bonds.
Granted, the bubble metaphor is not completely apt since home prices don’t “burst.” It’s a volume cycle, not a price cycle. Expect a sharp and long-lasting drop in transaction volumes but a very slow adjustment to prices.
The historical record is also clear about the consequences of a national housing bust. We have had 10 national housing busts since World War II.
Eight of them were closely followed by a national recession. The two exceptions occurred in 1966/67 and in 1951/52. Why were these different? It’s war.
Declines in spending on homes in those episodes were offset by increases in spending by the Department of Defense.
History thus offers a Hobson’s choice: a recession or a war.
*Edward Leamer is director of UCLA’s Anderson Forecast.
