17 February 2005

Since late 1995, housing prices have risen nationwide by almost 35% after adjusting for inflation

A steep run-up that is abnormal. In some regions, housing costs have risen by more than 50%. Could there be bubble trouble on the horizon?
The housing bubble most likely has its origins in another bubble—the stock bubble of the late 1990s, when investors used their Wall Street returns to buy pricier homes. The increased demand began to drive up prices; soon, homebuyers came to expect continued price increases and based their purchase decisions on that expectation. Homebuyers who may otherwise have viewed a $200,000 home as too costly became willing to pay that much in the expectation that the home would sell for far more down the road. Expectations of ever-rising prices drive speculative bubbles.

Sound familiar? Indeed, the current housing bubble is not unlike the run-up in stock prices to which it owes its origins. If and when this bubble bursts, as the stock bubble did, the economy will likely find itself in another recession, and millions of families will see their net worth disappear as their homes, particularly those in over-inflated housing markets, plummet in value. With nearly 40% of new homebuyers choosing adjustable-rate mortgages, and interest rates on the rise, some homebuyers could face increased mortgage payments even as the values of their homes fall. Those with high debt-to-equity balances could face negative equity, or the prospect of owing more than they own.

A weak job market and an otherwise stagnant economy has been kept buoyant by the housing bubble, which has not shown signs of receding, like has happened with the stock market, jobs and wage levels. In fact, home purchases have been a lucrative portfolio choice for many investors. But there are imminent warning signs like the record high mortgage debt to home equity ratio and continued rise in bankruptcies and foreclosures.


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