At 11:55 26/05/2005 -0400, you wrote:
Cross Country: Froth in Frisco or Another Bubble?
You can bet your life it's a bubble. Greenspan calls it "froth" because he's dreadfully afraid that he (and the rest of his Fed committee) will go down in the history books as being one of the instigators of what I think will be a major recession coming soon/ He held interest rates down for far too long to keep the consumer boom ging to help Bush in his first term. Besides San Fransisco there are crazy booms going on in other places in America -- Miami, for example. Vulture funds are ready hovering around, waiting for a slide.
But even vulture funds had better be careful because once housing booms burst they can be long-lasting. My house, for example, an architecturally-listed building (built 1786), lost 30% of its value in the great UK housing bust of 1989 and it took ten years to regain its value. But other housing in different parts of the country have still not recovered. In America, I believe that house prices (in real terms) in parts of inner-city Baltimore have still not recovered from the 1920 bust.
The present-day boom is all part of the excess-money syndrome which I wrote about in No 744. "The elephant problem" earlier today.
But I think that a minority of housing will be somewhat more recession-proof. I'm thinking of managed and gated communities in America, and some inner-city gated communities and some expensive village communities (in attractive countryside) in this country where security is a large premium in the price because of either their intentional design or naturally clustered traditional architecture (and where vigilantism is unobtrusive but of a very high order). (There is one such community within Bath that I discovered accidentally some years ago. I called upon a house late in the evening in a rich, but apparently ordinary-looking, neighbourhood and was set upon by an Alsation guard dog which bounded out of nowhere. Fortunately I knew what to do (stand very still and not stare at him/her) and was not injured, but several minutes later it became apparent from an unseen voice from behind the hedge of an adjoining house that this man had set the dog loose. When I explained my business to this unseen voice, then yet another [unseen] voice answered me from the house I was visiting! All very spooky, but this was a neighbourhood that knew how to look after itself! Such houses will carry a premium and no doubt the reason for it would be explained discreetly to a prospective purchaser with the right credentials. There are several housing areas in expensive parts of Bristol where they have private security guards who patrol in plain clothes unobstrusively -- normal visitors would never realise it.)
I mention all this not because I necessarily approve of such communities (though there are one or two gated working-class communities in London) but it's an indication (I believe) of what will increasingly happen in the coming years. The time and cost of commuting is going up all the time and there'll come a threshold when, fairly suddenly, a lot of people will start to rearrange their lives in what I call "work-home clusters". We have the faintest glimmerings of these in some countryside communities in this country where small specialist workshops and offices are grouped together and I'm sure there must be many more in America. There's one particular bond trader -- one of the world's biggest traders -- who works from an office in the basement of his home. British Telecom calculates that in this country over a million people work via the phone and Internet from their home (often at their own businesses) but calculate that another two or three million office workers presently working for very large employers (state and private) could easily do so. But it's the social isolation that's mainly preventing this development so far. Once some house-builders start designing clusters of houses where individual workers can also meet together conveniently at coffee-time, and once commuting time and costs start becoming very high then this will rapidly take-off I'm quite sure.
Keith
By Thomas Sowell
934 words
26 May 2005
The Wall Street Journal
A13
San Francisco -- Federal Reserve Chairman Alan Greenspan refuses to call the rapid increase in housing prices in recent years a "bubble" but does refer to it as having some "froth." Moreover, he sees skyrocketing housing costs as a problem in particular localities, rather than being nationwide.
One of these localities is the peninsula stretching from San Francisco to Silicon Valley, about 30 miles to the south. This is an area where housing prices are more than three times the national average and are rising rapidly. It is not that housing in this area is more grand than elsewhere, but that very ordinary houses have very grand prices. There are communities on the peninsula where the average home price is a million dollars and where it would be hard to find a house that anyone would call a mansion.
It is not the houses, as such, that are so astronomically expensive. It is the land -- and the high price of the land is due to severe restrictions on building anything on it. Before those land use restrictions -- "open space" laws, planning commission requirements and environmentalist regulations -- became severe during the 1970s, California housing prices were very much like those elsewhere in the country. Since then, California housing prices have been some multiple of the national average. Nowhere is this more true than in the San Francisco Bay area.
How can people afford to live where housing is so expensive? One of the ways of coping with high housing costs is with "creative" -- and risky -- financing. Roughly two-thirds of the home mortgages in the San Francisco Bay area are interest-only mortgages. Theoretically, you could make mortgage payments forever without acquiring a cent of equity in your home. You would essentially be renting with an option to buy, should your income ever reach the level where you could afford to pay something extra toward the principal.
In reality, the interest-only mortgage payments apply for only a limited number of years -- three to five years in most cases -- after which the payments rise, so as to contribute something toward the payment of the principal. People who expect their incomes to rise significantly in a few years assume that they will be able to handle the higher payments then. Of course that assumption can turn out to be wrong and the house can be lost.
Such desperate financial arrangements are due not only to the extraordinary housing prices in the San Francisco Bay area but also to a rapid rise of those prices, creating opportunities for speculative profits. During a recent month, home value appreciation averaged $2,000 a day in San Mateo, one of the communities on the San Francisco peninsula. Such rapid appreciation makes it possible to acquire significant equity in a home, even while paying nothing toward the principal on the mortgage loan.
The extraordinary rise in housing prices in the San Francisco Bay area in the past few years has been accompanied by a corresponding rise in the percentage of home buyers who resort to interest-only loans. As recently as 2002, only 11% of the new mortgages in this area were interest-only mortgages. But today 66% of new mortgages in the area are financed that way. While such mortgages are not as common nationwide, the upward trend extends across the country. Fewer than 10% of new mortgages nationwide were interest-only mortgages in 2002 but that has now risen to 31%.
Interest-only loans represent speculation on both rising personal income and rising housing prices. If either income or housing prices fail to rise at the expected rate, this whole financial arrangement can collapse like a house of cards, when higher mortgage payments become due and cannot be paid. Since interest-only loans can be expected to have adjustable interest rates, a national rise in interest rates will tend to raise these mortgage rates as well, driving up the monthly payments, even before any payments on principal are due, and exacerbating the rise in mortgage payments after the initial interest-only period has passed.
Individuals can decide for themselves whether they want to engage in such risky speculations. But the whole economy is affected if and when a speculative bubble bursts and housing prices collapse, while some homeowners lose their homes. While this risk is especially prevalent in the San Francisco Bay area, it is by no means confined to that area and its repercussions can be nationwide.
Consumer spending depends on wealth as well as income, and that spending can decline as people find themselves owning less than they expected. Housing wealth is not simply transferred to banks which foreclose on mortgages that are not being paid off. The value of a house, like the value of any other asset, depends on its prospects -- and those prospects obviously look better before a bubble bursts. Afterwards, there can be a net decline in wealth and spending in the economy as a whole. How much of a decline and how far the repercussions extend, if and when the bubble bursts, is the big question.
Let's hope that Alan Greenspan is right about the housing finance situation having just a little "froth" rather than being a real bubble. After all, just as a rising tide lifts all boats, so a falling water level risks all boats trapped in the same harbor.
---
Mr. Sowell, the Rose and Milton Friedman Senior Fellow at the Hoover Institution, is the author, most recently, of "Black Rednecks and White Liberals," published last month by Encounter.
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Keith Hudson, Bath, England, <www.evolutionary-economics.org>
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