Boy in the Bubble

Boy in the bubble



Is Alan Greenspan ready to admit that the housing market is clinically insane?


The word of the hour is "froth." A little like foam, a little like scum, the word appeared in nine different articles within the last three days in the Wall Street Journal. In economic terms, "froth" is no "irrational exuberance." Yet skeptics of the current housing boom took note when Federal Reserve chairman Alan Greenspan dropped the new F-bomb at the end of a recent 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 is this [real estate] market," the great oracle spaketh.


So what does "froth" mean? Though it certainly sounds effervescent, 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 yesterday 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 realtors trade group show that investments accounted for 23 percent of all homes purchased in 2004--roughly five times the historical norm. Another 13 percent were vacation dwellings. 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 even 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 deployed 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 the real estate economy as a 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 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. (These were the norm before the Great Depression's decade-long foreclosure-fest.)


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 dispatch the property before the bill comes due. Yet both groups could be laid low by fate (or, to be less charitable, by their own foolishness). 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. Stated in layman's language, that's less than nothing.


It's worth remembering that as recently as last year, the Fed chairman was 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. These days, Greenspan has returned to droning on in a fashion intended to put the dead to sleep. But the Fed's 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 economic risks and gotten on the case. Two years too late.

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