Will Katrina burst the housing bubble?

John W. Schoen Senior Producer • Profile • E-mail

As the scope of the damage from hurricane Katrina becomes clearer, Answer Desk readers are wondering about the wider economic impact. Bryan in New Haven is wondering whether the disaster's aftermath will be the final straw that bursts the housing bubble?

ILL WINDS FOR HOUSING?
What effect will Katrina have on the housing market "bubble" across the country? With so many destroyed homes in the Gulf area people now have no nest-egg to sell, which also leaves nothing for others to buy. I suppose those with good homeowners insurance could use the money to rebuild or purchase an existing home somewhere else. But how likely are people to rebuild versus renting for the rest of their lives? It seems like the old rules of housing Supply and Demand have been turned upside down. What are your thoughts on where this is leading?
          Bryan L., New Haven, CT

Katrina’s impact was so vast it’s hard to see how it won’t end up having a huge impact on many facets of the economy, including the housing market. But we suspect in the storm will also end up taking the blame for a lot of things it had nothing to do with — everything missed corporate profits to the flop of a new product. It’s just too easy an excuse to pass up.

So it’s hard to unwind Katrina’s impact on housing from all the other economic winds that were blowing well before the storm made landfall; there are a lot of pieces to this puzzle. There’s some evidence, for example, that buyers in overheated housing markets were already beginning to recover their sanity before the disaster struck.

And for the record, we’re not a big believer that housing bubbles “burst” suddenly – except perhaps for speculators who’ve overextended themselves. (Including all you Answer Desk readers who keep asking about how to “flip” real estate. Fair warning) When times get tough, people tend to stay put, which brings far less selling pressure than you get with, say, a stock market panic.

One way to answer the question is to look at the two major forces that have helped fuel the housing bubble in the first place: low mortgage rates and rising expendable income. If rates rise and home buyers' budgets get pinched, hot housing markets could cool quickly.

Let’s look first at interest rates, which are closely tied to inflation. Farmers are bringing in the fall harvest just as the shipping along the lower Mississippi River struggles to return to normal — a barge bottleneck could force food prices higher. Gasoline prices, already up sharply pre-Katrina, got a big boost from the lost refining capacity knocked out by the storm. The massive rebuilding that’s expected to begin soon will put a severe strain on supplies of building materials, potentially raising those prices. With the insurance industry and the federal government flooding the region with tens — maybe hundreds — of billions of dollars at once, it’s easy to make the case that there’s a risk of higher inflation. 

So far, consumer prices overall seem to be under control, though consumer inflation has picked up — largely due to higher energy prices. That could get worse when soaring winter heating bills hit home. And when it does flare up, inflation usually brings with it higher long-term interest rates — as investors demand higher payback to protect their money from the corrosive impact of inflation. A sizeable jump in rates could easily throw cold water on the housing market. (Again, so far, there’s no sign that’s happening.)

Now let’s look at incomes. It’s clear that unemployment will be widespread in the region as hundreds of thousands of displaced workers find themselves out of a job. It’s far from clear how many businesses will return — or how long it will take them to get back in business.

Some people in Katrina’s path may collect insurance payments, unemployment insurance or other storm-related government assistance. But that still leaves them with less of the long-term buying power needed to buy a home. Consumer budgets also could be further strained by higher prices (see above). And worries about all this could further hurt consumer’s confidence in the economy, which may prompt people to postpone house-hunting until Katrina’s impact becomes clearer.

In the end, bubble’s burst for a variety of reasons — even though, after the fact, one factor or event may get singled out for the full blame. The Internet bubble, for example, burst because investors finally came to their senses — for a variety of reasons. We’d suggest that the era of runaway housing prices will likely end for roughly the same reason.

MORE FROM ANSWER DESK

Answer Desk Section Front

Answer Desk: The peril of predictions Who'll take California IOUs? Slow stimulus spending Raiding college savings There’s a reason GM stock is cheap Housing rebound may be slow Beware the hidden agendas of 'experts' Meltdown will leave vastly changed economy Yikes! Series I Savings Bonds paying 0.0% Who's going to fix my Pontiac? Answer Desk Section Front   Add Answer Desk headlines to your news reader: