Housing Bubble

I read about a psychological experiment where subjects traded cards with numbers on them, and price bubbles were always formed. We all learned the hard way a few years ago that bubbles are followed by big crashes. Since the dot-com crash and 9/11, low interest rates motivated most investors to go into real-estate and the frenzy got started. I even know someone who bought a house quickly right before getting laid off to take advantage of home equity loans. And in the one year that he was unemployed, he lived happily off the appreciation on his house.

However, some recent stats indicate that we’re in a bubble. The ratio of house price to rent (the most similar metric to a stock’s PE ratio) has increased significantly. People are literally using their house as an ATM machine to take out loans. On average, people in the Bay Area only own about 8% of their houses. New mortgage instruments allow buyers to only pay the interest on the loan and buy houses not commensurate with their salaries. The old rules of 20% down and total house payments being between a quarter to a third of income are completely ignored.

Has crashes happened before? Yes. Look at Japan. Prices there now are below what they were in the early 90’s. This has also happened in LA after the cold war ended where some people literally drove to the bank to return the keys to their house since the remaining mortgage payment was significantly more than the value of the house. It took 8 years for the market in LA to recover. Bubbles always burst for a reason. What will be the needle this time?

My prediction is based on the interaction between national and regional economies. At some point, the US economy as a whole will start to grow and enter an inflationary cycle. At that time, the interest rates (which are tied to the national economy) will rise. The regions behind the national growth will see a disaster as their local unemployment rates, salaries, and GDP growth do not warrant the nation-wide higher interest rates. So buying a house today is taking a bet that your city will do better than the nation in next few years. And this is why I’m scared about the rapid price increase in areas that are dependent on the ‘old’ economy.

There is another alternative. As people prosper from the current boom, enough money can be pumped back to the economy to improve things enough to justify the boom. It’s an interesting phenomenon. I read an article recently that the improvements in the job market in Seattle for the past year have primarily been because of the booming housing market. But I am going to continue to enjoy the no-hassle life of renting. When a light bulb dies in my place, I send an email and it’s taken care of. I love it.