Housing headlines are dominating the news these days in the same way the Nasdaq did in the late 1990s.
And no wonder. Successive years of sizzling sales and spectacular price appreciation have given way to falling sales and starts, record inventories of unsold homes (new and existing), a plunge in housing affordability and a flattening out of prices on a nationwide basis. The residential real estate market may never match the Nasdaq’s vertiginous 78 percent decline from the 2000 top to the 2002 bottom, but it is captivating potential sellers, late-to-the-party speculative buyers and analysts looking to assess the impact on the overall economy.
… One area that has received next to no attention is the risk to the banking system, which, like everyone else, got caught up in the housing-market froth, extending credit seemingly without much due diligence. [emphasis added]
Over the next year or so, as the real estate market begins to soften, where will home prices remain highest? Potential buyers should look for more than beachfront location, nearby golf courses, or even good schools to determine whether their investment will be a smart one. The best thing to find? A strong local economy.
Nationwide, July’s sales of new homes were down more than 21 percent from a year earlier and the inventory of unsold new homes hit an all-time high.
Residential building permits are down nearly everywhere. So far this year in the 11-county Twin Cities metro area, permits are down 18 percent. Comparing this July with July 2005, they are down 37 percent.
Sales of existing homes are slowing as well, according to the National Association of Realtors and other sources. For the nation as a whole, sales are at a 2½-year low and the inventory of unsold homes is at a record high.
So sales and construction clearly are down. Some interest rates clearly are up. The Federal Reserve started to constrict growth of the money supply two years ago, forcing its short-term target rate up by 4.25 percentage points since then. The prime lending rate is up about the same amount. Even so, mortgage rates — especially for fixed-rate loans — haven’t climbed as much.
Yes, these rates were a percentage point or so lower a year ago. They currently are at the upper end of a narrow band in which they have hovered for four years. They remain very low by historic standards and in comparison to inflation.
… So if mortgage rates are not all that high when compared with long-run averages and adjusted for inflation, what is going on in housing?
… The most important factor, however, is that real estate and construction were in an unsustainable boom. Many people were building and buying houses with the primary objective of selling them for a profit.
Such booms are self-propagating for a while but must eventually die out even if interest rates do not rise. Irrational exuberance is fun while it lasts. When it abates, there is a frenzied rush for the door and someone always gets trampled.