An Update on the Housing Bubble
I have been of the opinion that we are in a housing bubble for four years now, which means I have been wrong, although, I have always maintained that the bursting of said bubble was not inevitable, but certain if several factors fell into place. Well, these factors are falling into place and actually getting unforeseen help from the President's tax reform commission.
My central thesis has been this: housing has benefitted from the fact that it has been an asset class with no competition and cheap access. The cheap access is well known - low mortgage rates - but the lack of competition from its traditional competitor asset classes has been an ignored factor in my opinion. First, stocks. They became radioactive as the Internet bubble burst and the wave of corporate scandals rocked th nation's confidence in this asset class. Second, bonds. In response to 9/11, the Fed drove rates way down, rendering the yields that investors could receive on their lendable capital meaningless. Cash reserves earned you less than 1% in the early aughts ('00s). Piddly. That left housing (commodities too, but most average people are not comfortable investing in commodities). Easy money and the lack of alternatives sent real estate into the stratosphere. Other, tangential factors that further drove the real estate market were the cheap dollar, which atracted foreign buyers and the surging cost of homebuilding materials, which drove up the replacement cost of existing homes.
Now, much of that is reversing. Bond yields are getting back to acceptable levels and banks are tripping over themselves to get your deposits, offering 3.5% and up on your cash. Stocks haven't regained the trust of most people, but as taxes on dividends and cap gains have gone down, they are harder to ignore. The dollar has gained back some significant ground, so our housing market is looking like less of a deal to foreigners. The only thing that I see that hasn't reversed noticably have been building materials. When insulation, lumber, glass and roofing materials come down in price, the picture will be complete.
This is all very neat and tidy but it still ignores an important factor - sentiment. All the logic in the world is often not enough to counter prevailing sentiment, which Keynes (blech!) dubbed "animal spirits". I have blogged here and here about the importance of animal spirits behind the housing boom and argued that factors which impact those spirits are more dangerous to the housing boom than the gradually shifting economics. I argued that the rate increase on Sept 20 was the first in a wave of things that would whack the animal spirits drving the housing market. People can easily see an 8% 30-yr fixed again and air is seeping out of the market already. Now comes the Tax Reform Commission to suggest that the housing mortgage deduction should be rethought (not a bad idea, if not the best idea coming out of the commission). Granted, this may never make it through the Great Sausage Factory, but the fear that it might would be enough to make homebuyers think twice. Once this proposal hits the front pages, the housing market could be in for real trouble.
My central thesis has been this: housing has benefitted from the fact that it has been an asset class with no competition and cheap access. The cheap access is well known - low mortgage rates - but the lack of competition from its traditional competitor asset classes has been an ignored factor in my opinion. First, stocks. They became radioactive as the Internet bubble burst and the wave of corporate scandals rocked th nation's confidence in this asset class. Second, bonds. In response to 9/11, the Fed drove rates way down, rendering the yields that investors could receive on their lendable capital meaningless. Cash reserves earned you less than 1% in the early aughts ('00s). Piddly. That left housing (commodities too, but most average people are not comfortable investing in commodities). Easy money and the lack of alternatives sent real estate into the stratosphere. Other, tangential factors that further drove the real estate market were the cheap dollar, which atracted foreign buyers and the surging cost of homebuilding materials, which drove up the replacement cost of existing homes.
Now, much of that is reversing. Bond yields are getting back to acceptable levels and banks are tripping over themselves to get your deposits, offering 3.5% and up on your cash. Stocks haven't regained the trust of most people, but as taxes on dividends and cap gains have gone down, they are harder to ignore. The dollar has gained back some significant ground, so our housing market is looking like less of a deal to foreigners. The only thing that I see that hasn't reversed noticably have been building materials. When insulation, lumber, glass and roofing materials come down in price, the picture will be complete.
This is all very neat and tidy but it still ignores an important factor - sentiment. All the logic in the world is often not enough to counter prevailing sentiment, which Keynes (blech!) dubbed "animal spirits". I have blogged here and here about the importance of animal spirits behind the housing boom and argued that factors which impact those spirits are more dangerous to the housing boom than the gradually shifting economics. I argued that the rate increase on Sept 20 was the first in a wave of things that would whack the animal spirits drving the housing market. People can easily see an 8% 30-yr fixed again and air is seeping out of the market already. Now comes the Tax Reform Commission to suggest that the housing mortgage deduction should be rethought (not a bad idea, if not the best idea coming out of the commission). Granted, this may never make it through the Great Sausage Factory, but the fear that it might would be enough to make homebuyers think twice. Once this proposal hits the front pages, the housing market could be in for real trouble.
posted by Donny Baseball at 9:49 AM
1 Comments:
Too many factors unknown to me to provide a good answer, but I would say, as a sweeping statement, don't get serious until end of 2006 or into 2007. I am renting through mid 2007, with the expectation that I will be able to buy what I want then for 10-20% cheaper than today. But this is in New York, which is more volatile than the rest of the country. Advice would hold for Calif., Boston, Florida, DC, but maybe not places like Tulsa, Kansas City, Buffalo, Milwaukee, etc.
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