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Housing booms don't always lead to busts

Should you rent and wait to buy a house after prices fall? Don't get your hopes up. If history is a reliable guide, home values in your target neighborhood probably won't fall. But they might stagnate long enough for your income to catch up to prices.

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This year the Federal Deposit Insurance Corp. prepared a research report titled, "U.S. Home Prices: Does Bust Always Follow Boom?" The answer to the question in the title is no. Sometimes a housing boom ends not with a decline in values, but with prices leveling off or rising slowly.

The FDIC analyzed home-value data from the Office of Federal Housing Enterprise Oversight, or OFHEO. The regulatory agency tracks value changes in repeat sales or refinancings of single-family properties secured by conforming mortgages.

The first thing that FDIC regulators had to do was define boom and bust. The agency defined a boom as any market where values went up 30 percent or more in three years, adjusting for inflation.

Sticky situation: Defining busts
Defining a bust presented a problem. If the agency defined a bust as a 30-percent decline in three years, it would have a lot of booms but only five busts. "The reason this measure proves to be too stringent is that home prices tend to adjust slowly (or be 'sticky downward' in economists' terms) during a downturn," the report says. So the agency defined a bust more loosely, as a price decline of 15 percent or more in five years, without adjusting for inflation.

To recap:

  • Boom: 30 percent rise in three years, adjusting for inflation.
  • Bust: 15 percent drop in five years, not adjusting for inflation.

Keeping in mind that the definition of a bust is looser, the FDIC identified 63 markets that had enjoyed housing booms from 1978 to 2003, and 21 markets that had suffered busts.

That 3-to-1 margin might be misleading, because prices in some markets might not have had time to decline 15 percent in five years. If you disregard the last five years that the study encompassed, and look at just 1978 to 1998, you end up with 54 housing booms in 46 metro areas, vs. 21 busts. (Eight areas had two booms: The California metro areas of Los Angeles-Long Beach-Glendale, Oxnard-Thousand Oaks-Ventura, Sacramento-Arden-Arcade-Roseville, San Diego-Carlsbad-San Marcos, San Francisco-San Mateo-Redwood City, and San Jose-Sunnyvale-Santa Clara, plus Seattle-Bellevue-Everett, Wash., and Honolulu.)

"Only infrequently do home-price booms lead to busts, at least by our criteria," write the study's authors, Cynthia Angell and Norman Williams.

They sharpened their pencils a bit more. If a bust happens more than five years after a boom, is it fair to say that the bust resulted from the boom? No, Angell and Williams contend. Nine busts happened within five years of those 54 booms. The other 12 happened long after booms.

"If it is relatively rare for housing booms to result in a price bust, how do booms usually end? Our look at history suggests that stagnation in home prices is often the most likely outcome," they write. In a typical period of stagnation, values rise about 2 percent a year for several years.

Job losses, not booms, cause busts
If booms don't typically cause busts, what does? Usually, severe local recessions force people to move away to find work, and home prices crater because there are many more empty houses than buyers. That happened in oil-dependent cities from Alaska to Louisiana when petroleum prices crashed in the 1980s. It happened later in California and New England, after the Cold War ended, and the United States needed fewer war planes, ships and submarines.

Angell and Williams trace all but two of the housing busts to falling oil prices and the end of the Cold War. The exceptions were Peoria, Ill., and Honolulu. Peoria's home prices fell in the recession of the early 1980s when demand for Caterpillar construction equipment dried up. Honolulu's home values dropped when the tourism industry was bitten twice in the 1990s, first by the California recession and then by the Asian financial crisis.

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-- Posted: Aug. 25, 2005
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