WSJ : House of Cards?
If Rates Don't Kill the Boom, What Will?Plus, a Bubble-Proof Buy and a New Hedge
May 27, 2005
Choose Your Weapon
Mark Gongloff: Watching the housing market is sort of like a game of Clue before the murder. The victim is still alive and well, but we know he's going down. After the housing market is cold, it should be easy to finger the perpetrator. But for now, we're left to guess (Colonel Greenspan in the conservatory with the lead pipe?), and the perp might not be whom we expect.
Most players think a spike in long-term interest rates will be the bad guy, pushing 30-year mortgage rates out of the Garden of Eden and pricing would-be home-buyers out of the market. But what if long-term rates don't rise?
They've shown a stubborn unwillingness to budge in the past few years, despite robust economic growth and the Federal Reserve's campaign to tighten credit.
In fact, housing can fall even if long-term rates don't rise. Lehman Brothers chief economist Ethan Harris thinks the more likely scenario is that some minor event will spook speculators, leading to a "contagion effect" that chases them from all of the hot markets. "The history of speculative bubbles is that often they collapse for what appear to be minor causes," he says.
Other possible culprits? A recession would certainly do the trick. Interest rates would stay low in that case, but lousy job markets and falling paychecks could make that $500,000 two-bedroom condo in Sarasota lose its luster in a hurry. Or prices could simply get so ridiculous that first-time buyers couldn't reach them, no matter how rickety a financing ladder they build.
Another potential market-stopper could already be at work, according to UCLA economics professor Edward Leamer: a flattening yield curve. With long-term rates as sluggish as sea cows and Greenspan & Co. relentlessly raising short term rates, the gap between the two has tightened to nearly nothing. When the spread was very wide, banks raked in profits by borrowing at super-low short-term rates and then lending at high long-term rates. When the spread narrows, their margins get pinched, and they have less incentive to lend. Also, they have less extra cash to cover defaults, so they scrutinize new borrowers more carefully.
"[Lenders] will look at you with a much greater degree of scrutiny when that yield curve is flat," Mr. Leamer says, noting that an inverted yield curve (short rates higher than long rates) may have murdered the S&Ls during the last housing boom. Fewer borrowers mean fewer buyers, and you don't need a UCLA economics professor to figure out the rest.
The good news? According to two different models, one used by Mr. Leamer and the other by Lakshman Achuthan at the Economic Cycle Research Institute, the death of the housing boom is not imminent. Dr. Leamer believes it's still about a year away – maybe there's still time to buy!
What do you think will stop the housing market? Or is it just unstoppable? Write to us at tradingshots@wsj.com. If you want to share your thoughts but don't want your letter published, please make that clear.
Steady as She Goes
David Gaffen: If the housing market is akin to Nasdaq, circa 2000, Salt Lake City is a health-care stock: a slow and steady gainer that pays little heed to the frenzy all around it.
Since 1988, homes in Utah's capital have been practically risk-proof and bubble free. The Salt Lake housing market has posted just one annual decline over the period, a skimpy 0.5% decline in 2003. Median prices have never risen more than 16% on a given year; they have posted an average annual increase of 5.5%, according to the National Association of Realtors.
Such consistent growth is hard to come by. Even markets that have been closely associated with the bubble have gone through periods of retrenchment since 1988. Prices in San Francisco, for instance, actually fell between 1988 and 1993.
So if you're looking for a new place to settle -- or somewhere to run when you flip that Sarasota condo -- sunny Salt Lake City may be for you. Think picturesque views of the Wasatch Range and ice-cold winters.
Still, even Salt Lake might not remain froth free. There are signs speculation is emerging, says Kevin Larsen, broker and manager at the Salt Lake branch of Coldwell Banker. It's "becoming less of a bargain, as a result of bidding wars starting in the last three or four months," he says. "It's being fueled by a lot of California people who are priced out of their market."
Is there any such thing as a bubble-proof market? Would you move to another part of the country just to buy a cheap house? Write to us at tradingshots@wsj.com. If you want to share your thoughts but don't want your letter published, please make that clear.
Betting Against the House
Scott Patterson: As investors burned in the dot-com blowup painfully recall, a popping bubble can devastate a portfolio. But investors who shorted tech and telecom stocks in 2000 made out like bandits. These days, wouldn't it be nice if you could go short the housing market – or hedge some of the gains in your home's value?
Robert Shiller knows bubbles, and he might have just the solution.
The Yale University finance professor – and author of "Irrational Exuberance," a book that deftly called the dot-com bubble – is a lead figure at Macro Securities Research. The New York research group has developed financial instruments – called "MACROs" – that will be tied to a housing index that tracks property values in certain cities. By purchasing Up MACROs or Down MACROs, investors would be able to place bets on whether a property market is going to keep rising, or whether it's going to fizzle.
In effect, speculators could play the bubble: They could short the City of Angels and go long on the Big Apple, or vice versa. Homeowners in bubbly markets could hedge against a pop. They could stand to gain if the value of their homes go down. If property values keep rising, of course, the homeowners lose on their MACRO investments -- but at least their homes would be worth more.
These days Mr. Shiller is convinced the U.S. housing market is rife with bubble-like behavior. Home-buyer psychology today "fits in with the model of a bubble," he says. "It's a wishful-thinking atmosphere that develops the idea that everything is going to be all right, and there's the sense that you have to get in at any cost because prices are going to keep going up."
Robert Hartwig, chief economist at the Insurance Information Institute, says the MACRO securities may be the best -- and only -- way homeowners can protect the value of their homes. Speculators, including hedge funds, could help add liquidity to the market, he says.
MACRO Securities has filed plans for the new securities with the Securities and Exchange Commission. The company intends to roll out its MACRO securities later this year and, in its filing with the SEC, said it hopes to list the securities on the American Stock Exchange. It also has a deal to develop housing-price-indexed futures with the Chicago Mercantile Exchange.
Are you interested in hedging the value of your house? What market would you short? Where would you go long? Write to us at tradingshots@wsj.com. If you want to share your thoughts but don't want your letter published, please make that clear.
Parting Shots:
Warren Buffett, at Berkshire Hathaway's annual shareholder meeting, May 1:
"Certainly at the high end of the real estate market in some areas, you've seen extraordinary movement... People go crazy in economics periodically, in all kinds of ways. Residential housing has different behavioral characteristics, simply because people live there. But when you get prices increasing faster than the underlying costs, sometimes there can be pretty serious consequences."
* * *
The Wall Street Journal, March 6, 2000:
"… for now, the frothy buying conditions in some of the nation's biggest housing markets, especially for high-end-homes, worry economists, who remember how the housing market crashed in the late 1980s after some markets overheated."
posted by Henry @ 3:57 PM
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