By Andy Mannix
By Caleb Hannan
By Olivia LaVecchia
By CP Staff
By Aaron Rupar
By Jacob Wheeler
By Olivia LaVecchia
By Aaron Rupar
The word of the hour is "froth." A little like foam, a little like scum, the word appeared in nine different Wall Street Journal articles within three days last week. In economic terms, "froth" is no "irrational exuberance." Yet skeptics of the current housing boom took note when Federal Reserve chairman Alan Greenspan dropped a new sort of F-bomb at the end of a speech to the Economic Club of New York. "There are a number of things, which I think suggest at a minimum there is a little froth in this [real estate] market," the great oracle spake.
So what does "froth" mean? Well, it's not a "bubble": In his lunchtime address, Greenspan specifically noted that "we don't perceive that there is a national bubble, but it's hard not to see that there are a lot of local bubbles." In other words, a froth in the housing market may not burst, but what we find underneath it may be less appetizing than a convenience-store cappuccino.
It's no secret that the housing market has gone haywire. The National Association of Realtors announced last Tuesday that sales of existing homes leapt 4.5 percent in April to a monthly record, while registering price increases last seen in 1980. That economic iceberg would appear menacing enough, but the enormity of the speculative fervor lies below the surface. For instance, further data from the realtors trade group show that investment purchases accounted for 23 percent of all homes bought in 2004--roughly five times the historical norm. Vacation dwellings made up another 13 percent. The Fed has previously argued that houses, unlike stocks, can't be dumped at the first sign of price drops. But these rules mostly apply to homesteaded properties--not rentals in another state or condos that have yet to be built.
Like the margin investing that fueled the late-'90s stock bubble, this real estate speculation is largely being financed with borrowed money. A survey by one California research firm, cited in the WSJ on May 23, found that 2.2 million households dipped into their home equity to purchase additional real estate in the last year--double the number from a decade ago. Indeed, if you're inclined to see real estate as an economic house of cards, the joker at the bottom is the loopy lending market. According to the Mortgage Bankers Association, adjustable rate mortgages made up nearly two-thirds of all originations (by dollar amount) during the second half of 2004. Some 17 percent of these were "interest only" mortgages, in which the buyer secures a lower rate and makes no principal payments for the first five or ten years of the loan.
Adjustable rate mortgages are ideal for two groups of people: strapped home-buyers who can't afford to get their name on a property title any other way, and investors who intend to refinance or resell the property before the bill comes due. Yet both groups could be laid low. The first borrower is likely to suffer if her personal income doesn't climb steeply enough to cover the new monthly hit, which could easily double. (For reference, the Bureau of Labor Statistics reports that wages in Hennepin and Dakota counties increased a modest 2.6 percent between September of 2003 and 2004.) The second borrower could crack if housing prices fall, leaving the highly leveraged owners with "negative equity"--owing more, that is, than her real estate portfolio is worth.
As recently as last year, the Fed chairman was still touting the virtues of ARMs despite the existence of the lowest fixed interest rates in modern history--an unseemly attempt to stuff consumers' wallets and keep them spending at all costs. But the Fed's recent actions speak to a more immediate sense of alarm. Two weeks ago, regulators issued their first-ever set of guidelines for home-equity borrowing, in an attempt to manage credit risks and caution lenders. By next year, the Fed should have new rules for the wide and weird world of alternative mortgages.
Rest assured: As it did during the late-'90s stock bubble, the Federal Reserve has recognized the risks and gotten on the case--two years too late.
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