Boom or bubble? Many in the media have written about a "housing bubble." But most housing economists quarrel with the use of that term. What's really going on with house prices?

Mortgage Banking, April, 2006 by Neil J. Morse

Back in the halcyon days of the dot-com era, an offbeat upstart company calling itself funerals.com promised to "put the fun back in funerals." (In poor taste, we agree, but as you recall, rational thinking wasn't driving the business plans back then.) Apparently many investors got the pun (and defying all logic) sank scads of money into the venture, which--not surprisingly--never made much money. [??] Yet, in the exuberance of those times, countless "sure-fire" startups rushed to ride the still-new Internet wave of the mid-1990s, promising easy and uncountable wealth for all who got on board. [??] No wonder, then, that collapse was inevitable and that eventually the talking heads would roll out the word they keep handy for such dramatic market scenarios: "bubble." You know--like the kind children blow from a mixture of soap and water, which expands to truly impressive proportions until, just when you begin to believe maybe there are no laws of nature, POP, the bubble bursts. Business historians have often reminded us these chapters governed by groupthink "reality" frequently end in a sudden burst of vapor.

With the end of dot-com mania, around the turn of the millennium, the term "bubble" moved on to a new residence, attaching itself to another sector that was the source of frenetic investment. This is when we began to hear the now well-worn phrase: "housing bubble."

The official imprimatur came when former Federal Reserve Board Chairman Alan Greenspan warned more than a year ago that rapid price appreciation in property values "does not go on forever."

Despite the persistence of the term in the mainstream media, housing economists (those, arguably, who should know) have been battling the appropriateness of the term to describe real conditions in the housing market. Many of them have been saying for more than a year that home prices in many markets around the country are an outgrowth of supply and demand, although they have conceded there are a few markets with hyper-inflated prices poised to take a tumble.

Despite the storm warnings, some questioned whether it was in fact the Fed's strategy of lowering interest rates that had inflated a housing bubble, to which Greenspan replied--in hearings before Congress last June--that if so, it was "an acceptable price for avoiding another Depression or a Japan-like economic stagnation."

The new Fed chairman, Ben Bernanke, has taken a more sanguine position, stating publicly in February that housing would enter a moderate slowdown but not a crash.

Under Greenspan, the Fed had lowered its target for the Fed Funds rate more than a dozen times in the early 2000s, with the rate hitting an improbably low 0.98 percent by June 2003--the lowest level since 1959. That contributed to U.S. household debt hitting a record $11.4 trillion in the third quarter of 2005, according to Fed data.

Notwithstanding his earlier warnings of "irrational exuberance" in a 1990s stock market, driven wild by dot-com adventures, many believed Greenspan was right to, in effect, create conditions unleashing demand for homeownership that eventually drove up housing prices by 125 percent since 2000 in some parts of California.

Indeed, Irrational Exuberance was the name of a prescient 2000 book written by Robert J. Shiller, a professor of economics at Yale University, who told an interviewer just last year: "We're going through something very similar in real estate that we did with stocks. It's driven by the same forces [that insist] investments can't go bad; that they have the potential to make you rich; that you'll regret it if you don't [get in]; and that it looks expensive but is really not."

Shiller's view is shared by some, disputed by others and, all told, has produced the present debate about a housing bubble--which, depending on your slant, either does or does not exist; and either has, is about to or will not burst.

At the close of 2005, the U.S. Commerce Department deftly straddled these variant perspectives, reporting that even as home sales remained high by historical standards, they were starting to level off from relatively uninterrupted growth over the last four years. The Commerce Department later reported that January 2006 sales of new homes were down 5 percent, compared with the same month a year earlier.

Further adding ambiguity, the Commerce Department said the number of homes that builders started constructing in December 2005 fell 8.9 percent, to an annual pace of 1.93 million. Meanwhile, the median price for new homes--half the homes sold for more and half for less--augured a flattening, standing still in 2005 at $225,200, little changed from the year before.

Does this signal a peak in home-price appreciation or, more likely, a peak in what buyers can afford?

"People don't buy houses based on income," answers Amy Crews Cutts, deputy chief economist for Freddie Mac. "They buy based on the mortgage payment--[i.e.,] how much house they can afford at X amount per month." When interest rates rise and prices go up, but incomes do not keep pace, she says: "Something has to give."