Left Center Left

Speaking of my neglected blogroll, I’d be remiss in not mentioning the excellent blog that Cambridge-based The Real Estate Cafe has set up to track the housing bubble. Their latest post points out a frightening Washington Post piece about the rise in Adjustable Rate Mortgages. ARMs are hardly bad in themselves (after all, the premium on a fixed-rate mortgage is going to take into account the expected likelihood of future interest-rate hikes). They may be the best thing for individual homeowners. Collectively, however, they suggest that more and more homeowners are taking on financial risk to catch up with a rising market - and, conversely, that the market is being bid upward by those taking on such risk.

Also of note, South End realtor John Keith has been tracking local news on the real estate market and providing his gloss on it on his blog. He seems a little more skeptical than I that a bubble is underway, but has some good coverage of the issue, including an NPR interview with Robert Schiller.

I’ve written on the bubble plenty before, but maybe it’s worth collecting a few thoughts:

The housing bubble is really an interest rate bubble. All speculative bubbles - to the extent they’re not just localized ponzi schemes - involve too much loose credit driving up prices. Morgan Stanley’s Stephen Roach speaks of an “Asset Economy,” noting that

when the equity bubble burst, asset-dependent American consumers barely skipped a beat. Courtesy of an extraordinary shift to monetary accommodation, the pendulum of asset depreciation quickly swung into property markets; US house-price inflation has since surged to a 25-year high.

Essentially, buyers are able to bid up housing prices relative to income because of low interest rates, speculative expectations of future asset appreciation and a little irrational exuberance, too. See Brad DeLong on this, too.

The relation of local markets to the national asset-economy bubble is complicated. It’s not true that the bubble is simply the effect of local restrictions on housing in NY, MA CA and other hot markets. Rather, the constraints of supply in these areas mean that the bidding up of prices caused by low interest rates and speculative pressure exacerbate the upward trend and require a higher percentage of income stream from prospective buyers. Or, to frame the issue differently, the rise in demand in these areas has less to do with population growth or increased need of units than in the increased amount of money chasing finite supply of units.

That said, while it seems reasonable to predict a deflation of the housing bubble, predicting the price direction in specific neighborhoods is harder. What’s easier to suggest is that the differential between post-bubble prices and expected prices extrapolating during the bubble will tend to be negative: Beacon Hill may be desirable enough a neighborhood to hold its prices during bubble deflation, but if it does you can be sure that its price it would be less than it would have been

The housing bubble differs from a securities bubble. All stocks are all speculative, but housing is also a good with use-value. Some complain that people are buying houses as speculation instead of to live in, but the more complicated truth is that people increasingly see both as bound up in one another. That is, most people buy houses because they intend to live in them and because they think it’s a good investment. But assets don’t always appreciate or appreciate as quickly as you want them to.

The main danger of a housing bubble deflation is, oddly enough, not the effect for homeowners, but the macroeconomic effect. The deflation of a housing bubble won’t be bad for everyone. Individuals’ situations differ, and in any case many can weather out a medium-term dip in asset values. Those who have little down or paid off on their mortgage, and those who have borrowed extensively against the equity of their home may be in danger of negative equity. Also, as mentioned above, those with adjustable rate mortgages may find themselves unable to pay if interest rates rise dramatically. The main hazards, however, are collective ones. First, that collapse of mortgage solvency could trigger a crisis in government-backed mortgage securities, leading to either a bailout or a tanking of Fannie Mae shares. Second, the deflation will mean major contraction of aggregate demand. We have spent our way to some semblance of macroeconomic stability through this recession, and we have done so through borrowing against home equity, consumer borrowing and international trade/current account deficit. Reckoning will come on these fronts.

Assessing and addressing the hazards of a housing bubble shouldn’t be a left/right political issue, though somehow it’s become one. It’s not as if you can’t find bubble-skeptics on the left, or some credence given to the bubble’s existence on the right (say, in the Economist or at Marginal Revolution). It’s just that most of the concern does seem to be coming from liberals. And while neither party is exactly making a passable attempt to address this issue, the silence of the Bush administration on macroeconomic hazards is deafening. Which goes to my general theory that the Republicans as currently constituted are completely unconcerned by macroeconomics.

As usual, I’m talking without expertise here, so corrections and interventions more than welcome.