Feds no longer dismiss talk of housing bubble

Martin Wolk Chief economics correspondent • Profile • E-mail

When we first began writing about the possibility of a housing bubble nearly three years ago, economists who sketched a grim scenario of downward spiraling prices largely were dismissed as overly pessimistic cranks.

So far, their harsh projections have failed to materialize. But even the most optimistic housing industry boosters are beginning to worry, to wonder and to wish out loud for a cooling-off period.

There are growing signs that federal regulators would like to rein in some of the worst excesses of the current boom, including the increasing dependence on interest-only loans and other non-traditional lending products that can leave borrowers overextended, especially if interest rates rise or housing values drop.

What's all the fuss about? Consider:

• In California, the median price for an existing home has surged past $500,000 to the current $523,000, double the $262,000 median of just four years ago. In the hottest markets near the California coast, where two-bedroom cottages often go for more than $600,000, the asking price is often little more than a starting point for a bidding war. Nationally, home prices rose 12.5 percent over the past year, according to the most reliable federal figures.
• A study by the National Association of Realtors found that more than 35 percent of all home sales were for investment purposes or as second homes. And even with fixed mortgage rates near 40-year lows, more than one-third of borrowers took out adjustable-rate mortgages last year.
• Ten states and the District of Columbia have seen prices rise more than 70 percent over the past five years, and prices have more than doubled in 23 markets in California, Florida and Massachusetts, according to federal figures. In the same time frame, ordinary consumer prices have risen just 13 percent, and personal income has risen 23 percent.
• A cover story in the Economist magazine this month calls the global rise in housing prices “the biggest bubble in history” and warns of economic pain to follow. Declining prices in formerly red-hot markets of Britain and Australia offer a cautionary tale for what could happen in the United States, the magazine's editors argue.

Federal Reserve Chairman Alan Greenspan, who as recently as last year dismissed talk of a speculative housing bubble, now acknowledges that there are “a lot of local bubbles” in the housing market, although he sees nothing along the lines of a NASDAQ-type asset bubble that could deflate suddenly with national economic consequences.

In May, the Fed and four other regulatory agencies issued an unusual joint statement, warning that financial institutions  “may not be fully recognizing the risk” inherent in aggressive lending secured by rapidly rising home values. These home equity loans and cash-out refinancing deals have been a major engine for consumer spending in an economy characterized by relatively slow job and income growth.

Regulators are working on additional guidelines for non-traditional loans issued by primary mortgage lenders, a spokesman for the Federal Deposit Insurance Corp. said.

The proliferation of interest-only, "negative amortization" and various hybrid loan products is capturing the attention of regulators because they rely heavily on rapidly increasing home values and appeal to buyers who otherwise would not be able to afford a home.

Because borrowers who get these loans pay no principal — and often put little or no money down — they easily could find themselves "underwater" if home prices decline, meaning they owe the bank more than the home is worth.

Richard Brown, chief economist for the FDIC, said he worries that the easy availability of such mortgages is contributing to the rapid rise in housing prices.

“The broadening (of the housing boom) in 2004 was remarkable and pretty unprecedented,” said Brown, "It does add some concerns if credit conditions are pushing prices up.”

A study by the FDIC, which insures bank deposits, found that inflation-adjusted housing prices rose by 30 percent from 2001 to 2004 in 55 metropolitan markets. That was up from 33 markets in the 2000-2003 period.

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