Analysis: Houses without foundations

By IAN CAMPBELL, UPI Chief Economics Correspondent  |  April 10, 2003 at 10:46 AM
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"I live in the San Francisco Bay area. Unfortunately for me, I still don't own a home. However, if I could afford one, I wouldn't buy now."

The above is the opening of an e-mail from a reader of our article on the housing market entitled "Greenspan's second bubble," published March 4 (and still available on

The reader, who wishes to keep his identity secret, provided us with comments on his finances and those of his landlord that, we guess, many other Americans will relate to. To our mind the reader's comments pointed succinctly to the unhappy realities underlying, but not underpinning, the booming U.S. housing market. We quote further from the message below. First our correspondent looks at his area, one that bubbled vigorously in the U.S. boom of 1990s and that is among the worst hit areas now in the economic slowdown.

"At some point, all the homeowners who belong to the almost 200,000 folks who have lost jobs here won't be able to refinance in order to take out more equity. Something will give, and folks will have to trade down, become renters, or move elsewhere."

The view might seem to some an overly negative one. What if the economy picks up and unemployment begins to fall? This is the basis of essentially optimistic forecasts from the Mortgage Bankers Association, the National Association of Realtors and many U.S. economists.

Listen to this from Doug Duncan, the chief economist of the Mortgage Bankers Association: "We expect to see delinquencies fall as the economy improves and generates jobs growth. We are seeing some signs of improvement."

The real estate professionals still say houses are a good buy.

"In addition to a strong fundamental demand for housing, economic uncertainty is favoring more stable investments such as homeownership," said National Association of Realtors President Cathy Whatley a couple of weeks ago. But let's hear more of what our reader has to say:

"My landlord was making $160,000 when he bought our house in May 2001. He paid $515,000, and put about $25,000 into the house in paint, small repairs, and replacing the lawn. He's only worked about six of the last 18 months, and is now doing odd jobs as a handyman."

The landlord, then, is one of the almost 3 million Americans who have become unemployed in the past three years. From a very high salary he has been reduced to odd jobbing. To help meet the mortgage payments on his half million dollar house, however, he has rental income. But that, too, is falling. Our reader, his tenant, spells this out as well:

"In June 2001, we rented the house for $2,195 a month; now we've negotiated downward to $1,995, and figure the market is between $1,895 and $1,995. Meantime, he's basically unemployed, and paying principal and interest on a 30-year fixed, plus taxes. You do the math. If he can't hold on, he'll take a bath on it, and if he can, his cash flow is horrible."

Our reader has, then, negotiated down the monthly rent he pays by $200, 9 percent of the total. A news clip from a San Francisco Bay area newspaper, the San Jose Mercury News, shows that this reduction in rents is by no means an isolated phenomenon.

"Average rents in large apartment complexes in San Jose declined from about $2,220 at the end of 2000 to $1,430 for the first quarter of 2003, according to Axiometrics," an independent real estate research firm.

The drop in rents found by Axiometrics is of 36 percent in a period of a little more than two years, from the final days of the U.S. economic boom to the beginning of this year.

The story from our tenant goes a little further. He sub-lets part of the large house: "At the same time, we have a couple of roomers to make ends meet. When we moved in, we filled the rooms at $575; now, $450 is the best we can get, and our house is spotless, and it took us three months instead of three weeks to find someone."

And so the room rent has dropped by 22 percent since mid-2001, an abrupt decline, in line with the large falls that the Axiometrics research firm has found in its studies.

The boom in U.S. house prices has been based on "affordability." The short-term interest rate set by the U.S. Federal Reserve is at a 40-year low. The Mortgage Bankers Association of America's refinancing index rose to its highest ever level in February as home-owners took advantage of 30-year fixed rate mortgage rates that dropped as low as 5.6 per cent, the lowest rate in decades. But the U.S. fiscal deficit is soaring, suggesting that there may be growing upward pressure on long-term interest rates as the government itself issues more and more debt.

A perhaps still more immediate threat is the danger that our reader's letter points to: that even with interest rates very low, some Americans are beginning to find it difficult to afford the cheap mortgages they have.

House prices normally rise most strongly in a strong economy, when incomes are high. But now it is ultra-cheap (too cheap!) money that is driving house prices up in the midst of a weak economy. Meanwhile, making the phenomenon still more dangerous, the booming housing market is itself the main prop of the weak economy, the prop preventing it from sinking into recession.

It is the sort of conjuring trick we might see at the circus, the spinning globe balanced on the top of a pole held by a clown riding on one leg on an elephant's back. The pole is the housing market; the spinning globe the U.S. economy.

"Prices are sticky downwards," is a phrase out of textbook economics. It means that prices rise more easily than they fall. People sell for a higher price readily, for a lower one reluctantly. Yet home rental prices are dropping steeply in at least some parts of the United States.

House prices are more "sticky" than rental prices. People do not want to sell for a lower price than they paid. They do not want to lose money, particularly when they have a loan outstanding. But fall house prices will, exposing many who have bought at the peak to equity losses and further damaging the prospects for the U.S. economy.

Something has got to give, wrote our reader from San Francisco. He's right. The soaring housing market is the final consequence of the false 1990s' boom: a side effect of the medicine liberally doled out by the Fed to try to save a deeply sick post-boom economy. The cheap money, keep the balls up in the air trick of the 1990s is being repeated, in housing now, rather than in stocks. As it was then, it is a mistake to listen to the industry's cheerleaders. The soaring houses have no foundations.

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