Housing bubble may be illusion, but choices are real
Either the United States is inside
a colossal housing bubble that's about to pop, or there's little
to worry about. It depends on whom you ask.
The debate over the existence of a housing bubble has been going on
for at least two years. A "bubble" happens when frenzied
buyers bid up prices artificially high. Eventually, the bubble bursts
and prices plummet. Believers in a real estate bubble worry that years
of low interest rates have inflated home prices beyond reason. They
warn that the inevitable rise in mortgage rates could cause a coast-to-coast
plunge in values that would have hideous effects on the economy.
The debate over the existence of a bubble is important
because most homeowners have to choose whether to protect themselves
from rising home prices or from falling home prices. Home buyers
make that choice, whether they realize it or not, when they decide
how much of a down payment to make and what type of loan to get.
Playing bubble jeopardy
Many buyers nowadays borrow 90 percent or more of a home's price
just so they can buy a place before even the least-expensive houses
in their areas are out of reach. They figure they can move up to
a better house in a few years. Some of these buyers get adjustable-rate
or interest-only mortgages. They stretch their finances to protect
themselves from further increases in home prices, but that makes
them vulnerable to dramatic drops in values.
By most accounts, fewer buyers are doing the opposite:
protecting themselves from a bubble. The best bubble-protection
strategies consist of saving up for a hefty down payment (of 20
percent or more), avoiding bidding wars for houses in hot markets,
shunning interest-only loans and buying houses for the long term.
People who warn of a housing bubble say that home
prices have risen dramatically in the past eight years, faster than
the overall rate of inflation, while rents have not kept pace. They
acknowledge that real estate markets are local, and that all real
estate bubbles in the past were local. But they say the past few
years' rapid run-up in home prices has been national and unprecedented,
so a nationwide drop in values is possible.
The rate-price link
Stephen Roach, chief economist for Morgan Stanley, believes that
low mortgage rates are driving up house prices artificially. He
compares what's happening in residential real estate today with
the dot-com bubble of the 1990s, and has urged the Federal Reserve
to raise short-term interest rates now, to deflate the bubble before
it gets bigger.
Dean Baker, an economist and co-director of the Center
for Economic Policy and Research, agrees with Roach that low mortgage
rates have inflated a bubble. He says the fad for cash-out refinances,
equity lines of credit and high loan-to-value mortgages are signs
of a bubble. Baker believes so confidently in a housing bubble that
he sponsored a $1,000 essay contest to solicit the most-convincing
argument for the other side.
Experts disagree on bubble's
The winning essayist, Hilary Croke, is a researcher for the Federal
Reserve. Expressing her personal views and not those of the Fed,
she argues in the essay that the steep rise in prices in recent
years is nothing new, that demand for housing is high and supply
is low and that houses are bigger and better than they used to be.
All of these factors push up prices.
She adds that home prices have risen much faster
than rents because the "benefits of homeownership together
with easier access to credit has made rental accommodation less