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House

The real estate market is at an all-time high across the globe and is driving America's economy. What could possibly go wrong?

12:00 AM, Aug 30, 2005 • By IRWIN M. STELZER
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VERY FEW MARKETS are as complicated as the housing market, which may be why it so confuses market watchers. One week the New York Times reports "Healthy Housing Market Lifted the Economy in July," the next week the same writer discovers, "July Slowing of Home Sales Stirs Talk of Market Peak."

This confusion is no trivial matter, since the housing industry has replaced the auto industry as the driving force in the U.S. economy. Bureau of Labor Statistics data compiled for me by Diana Furchtgott-Roth, a colleague at the Hudson Institute, show that the housing and related industries now account for 4.8 million jobs, some 60 percent more than the once-mighty auto industry. Whereas the auto industry has desperately shed 60,000 jobs in the past 4 years so as to reduce its future pension and health care costs, points out Furchtgott-Roth, the housing industry has created almost 600,000 jobs in the construction and financial services.

Indeed, even the newspaper industry is a beneficiary of the booming housing market: Even though 74 percent of U.S. home buyers used the Internet in their search for homes, real estate ads in papers such as the Los Angeles Times and the Dallas Morning News were up 45 percent and 34 percent, respectively, according to the Wall Street Journal.

In one sense, the industry consists of a series of very local markets. As any prospective home buyer knows, the street on which a house is located, much less the neighborhood or the town, can importantly affect the value of that house. So when Federal Reserve Board chairman Alan Greenspan says that there is "froth" on some markets, he is careful to point out that we have never had a nationwide collapse in home prices, at least not since the Great Depression.

But there is another sense in which the housing market is national, rather than merely local, in scope. Interest rates and the jobs market importantly affect the affordability of houses and consumers' willingness to take the plunge into home ownership. So the low rates that have prevailed in the United States, and the recovering jobs market, account for the nation-wide spurt in home building and buying.

INDEED, the housing industry is no longer insulated from the globalization trends that characterize other markets. Investors from Germany to Abu Dhabi to China to Australia (our friends from Down Under have replaced Germany as the leading investors in U.S. commercial real estate) are pouring money into mortgage-backed securities, providing lenders here with still more money to lend to prospective home buyers, many of whom have substandard credit ratings. Meanwhile, proof that housing markets around the world are connected by the common forces of interest rates and job growth can be seen by looking at prices around the world. The Economist reports that the 13.0 percent rise in prices in the United States between the third quarters of 2003 and 2004 was topped by increases in Spain (17.2 percent), New Zealand (16.4 percent), France (14.7 percent), and Britain (13.8 percent).

SO WILL IT ALL END IN TEARS? Will the 5-year boom that has seen average prices increase by 50 percent in the United States (and by that much in the past 12 months in Phoenix) prove to be a bubble? After all, Goldman Sachs reports, "Relative to per-capita GDP, a typical home in San Francisco now costs much more than one in London." And economist Robert Schiller, famous for having warned that the stock market was over-valued before investors found to their pain that he was correct, now warns those predicting continued rises in house prices, "Beware."

Whether we will see a gradual cooling or hear the sound of a bubble bursting will depend on the interaction of all of the forces playing on the market: the willingness of international investors to continue pouring money into mortgage-backed securities, which now exceed in market value the total of all U.S. Treasury securities outstanding; the Fed's desire and ability to drive up mortgage rates; and very local conditions of supply and demand.

Recent data provide little guidance. Just last week:

*The National Association of Realtors reported that sales of existing homes fell by 2.6 percent in July, but that sales of new homes rose by 6.5 percent from June, and by 28 percent from July 2004, to a new record. To add to the confusion, despite the July fall, sales of existing homes were 4.7 percent above year-earlier levels, and the median price for these already-built houses (the price at which half sold for more and half for less) was 14.1 percent above the level reached a year ago. But prices for new homes fell by 7.2 percent in July, and are now 4 percent below last year's level.