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March 1, 2006

Bubble Bursting Would Be No Big Deal

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Times columnist David Lenhardt looks the real estate bubble straight in the eye and shrugs. While some people, particularly those with a pressing need to downsize or move to a cheaper market, would feel pain if prices fell 25 or 30 percent, existing homeowners should be fine and may even find a pull-back to be an opportunity to trade up:

Instead of panicking, most homeowners should be taking a deep breath. The real estate slump of 2006 offers a fresh chance to puncture the No. 1 myth about the nation's No. 1 topic of conversation: the idea that we should all be rooting for high house prices. The myth is good for real estate agents, but it creates needless anxiety for everyone else. It's time that most of us learned to stop worrying and love the bursting bubble.

Don't Fear the Bubble That Bursts [NY Times]




Posted by Brownstoner at 9:02 AM | Comments (16)
Categories: Market

Comments

He's probably right - it's a pretty rational standpoint. Hasn't everyone always said you're ok if you're not planning to move for 10 years?

What will end I think, and may affect homeowners, is the "housing ATM" - no more HELOCs or refinancings for home improvement projects or whatever else people use that money for.

Posted by: Anon at March 1, 2006 9:35 AM

A drop of 30% would probably be a good thing for the overall health of the New York economy putting housing costs more in line with people's actual income.

This can be different from the past corrections in a number of ways though. First, many americans have borrowed heavily against the value of their homes and with American's negative savings rate, the mortgage refinancing has driven alot of consumer spending, if this dries up, it could really hit consumer spending which is the engine of the world economy.

The current boom coincided with the Baby Boomers being at the height of their earning potential with many buying second homes, often as investments. As Baby Boomers downsize, this could lead to more housing supply. Lastly and of most concern, the US economy has really become a real estate economy over the last five years and if this critical economic sector slows, it does not bode well for the otherwise anemic US economy. Throw in the inevitable dollar devaluation (is the housing bubble tied to the overvalued US currency?) and things could get ugly.

But barring the worse case scenarios, this may be a healthy thing in the long term.

David Lenhardt needs a new photo! Very Six Feet Under looking.

Posted by: GrandPa at March 1, 2006 10:01 AM

I'd have to agree that letting some air out of the bubble would not be a bad thing, so long as the floor is reached in an orderly manner. I'm a b-stone owner with substantial equity. Whether my equity is $1MM or $2MM will make no difference to my lifestyle. I decided a short time ago, after getting over my bubble giddiness, that I'd better focus on savings, not home equity.

If prices in the region dropped by 30%, I'd be disappointed, not devastated, and probably in the market for a weekend home. Plus, over the long haul, I have no doubt that the home will prove to have been a very important and valuable asset.

Posted by: Miguel at March 1, 2006 10:29 AM

While most of his argument is sound reasoning, I disagree on his assertion that the mortgage interest deduction "hands out $80 billion a year in subsidies".

The reason why this is not entirely true is because like every other upside to home ownership, the tax benefit is then built into the price. Just as buyers recognize the benefits, so do the sellers, and the price of the home raises by just as much.

To fully understand this point, you may refer to a blog post I wrote about here: http://iceberg18.blogspot.com/2005/12/subsidizzied.html

Posted by: iceberg at March 1, 2006 10:45 AM

I bet Lenhardt was still in grammar school when the last bubble burst, or he wouldn't be so ridiculously sanguine. Lots of people found themselves owning houses and apartments worth less than the mortgage on them -- translation, bye bye down payment and equity. Lots of people who had another kid had to sell a small place, losing tens of thousands of dollars, and making it hard to find a new place they could afford. Basically, those who could stay put came out OK in the end, eight years later. Those who couldn't often took a bath. (Made work for lawyers and brokers in the "work-out" business, a term Lenhardt doesn't mention, but that was the only immediate up-side.) In some neighborhoods, houses just didn't sell.

Think about it. You've just bought that two-bedroom apartment in Park Slope for $800,000 and prices drop 25%. Fine, until your second kid comes along and that 1000 square feet is awfully crowded. But what can you do? Hope you've got a trust fund in your future, I guess.

When the bubble bursts there will be losers. Who they are and how much they lose and for how long depend on lots of other factors.

Posted by: David in NY at March 1, 2006 12:00 PM

looks like this will be the end of a very time consuming conversation piece, most americans can now focus on more important things like family, as long as they are not jumping out of b uilding because they took out too much credit

Posted by: Anonymous at March 1, 2006 12:18 PM

As David in NY says, it depends on a lot of factors, but people looking to trade UP will do better in a down market so long as their income is stable and the overall economy does not get in a hand basket (2 significant “if”s).

I needed larger space in 1993 than the small-ish loft I had bought in 1987. When I bought a much larger loft in 1993, I lost a chunk on my smallish loft *but* the gap to the larger apartment I needed had shrunk. Lucky for me, the new loft tripled in value since 1993. Leonhardt addresses this in a sideboard that did not make the print edition, but is on line at http://www.nytimes.com/2006/03/01/business/01leonhardt_side.html?n=Top%2fReference%2fTimes%20Topics%2fPeople%2fL%2fLeonhardt%2c%20David

BTW folks, Leonhardt uses 12% for the 1988-1995 dollar price drop, then converts this to “nearly 33% in inflation-adjusted terms”. I see business writers make that inflation adjustment for real estate values a lot, but have not noticed them making the same adjustment when talking about, for example, stock market values.


smatti

Posted by: smatti at March 1, 2006 12:37 PM

iceberg, that's absolutely true, but doens't that also mean that tax policy is artificially raising the price of housing, pricing out those potential buyers on the margin?

Sorry if you say this in your blog, don't have time to read it.

Posted by: grendel at March 1, 2006 1:09 PM

grendel,

Yes that is true, that part and parcel with a subsidy will be the shifting of prices to include that tax advantage in the price.

The subsidy also leads to malinvest in home ownership, (which also helps to depress and distort the rental market) but raises the price on either option.

Eliminating the subsidy will cause a drop in prices, while not overnight, but to speak of "$80 billion" in subsidies as if it exists independent of the tax laws, instead of being the tax laws own creature is what confuses such people.

The $80 billion in subsidies will disappear as soon as the home prices drop by that much, so there is no real $80 billion for some politician to waste on another social program, nor will there be when the mortgage interest tax deduction is laid to rest.

Posted by: iceberg at March 1, 2006 1:25 PM

grendel and iceberg,

You both get this wrong. Supply curves are upward sloping so shifts in demand along the supply curve would result in reduction in prices (and housing consumption), but by less than the total current tax deduction.

The reduced prices would not result in $80 billion dollars less in interest being paid and deducted.

Home prices would fall and tax revenues would rise, but by somewhat less than the current mortgage interest deduction.

The chief objection to the tax deduction is that it cause under consumption/investment in other commodities and capital which is not necessariy in our best interest long-term.

We have massive pristine brownstones, but poorly educated children, crumbling subways, soaring energy costs, etc.

Posted by: bkborn at March 1, 2006 2:30 PM

Do you honestly think the federal government would use the new tax revenue for education, energy alternatives/conservation and urban infrastructure? The repeal of the interest rate deduction will not likely happen in any event, and if it does, would be a long way off.

Posted by: Anonymous at March 1, 2006 3:20 PM

Since 9/11 the bubble heads have been predicting the end is near. I can't wait for the 5th annual New York Magizne "The Sky is Falling" issue. The main fact is NYC is not like the rest of the country. The local economy is driven by "FIRE". Finance,Insurance,and Real Estate. As long as they remain strong and more people continue to move in than move out, the law of supply and demand will rule.

Posted by: Anonymous at March 1, 2006 4:36 PM

I live for the "NYC is different" argument. Seriously, people here have made good arguments for and against - that is definitely the worst one of all. NYC has had its real estate collapses, same as everywhere else, and it can again.

Posted by: Anonymous at March 1, 2006 5:27 PM

If anything, our increasingly concentrated, FIRE-based economy is adding more potential volatility in the real estate market than in other parts of the country of the country. FIRE is facing increasing competion from abroad in ways that other industries and their associated regional economies are not.

Hollywood gains world market share in entertainment every year. Florida gains tourism market share every year. Texas gains oil revenue every year. Hence, these areas are gaining population at a much faster clip the NYC.

Meanwhile, european stock markets, electronic stock markets, Irish/Carribean Insurers and global investment banks keep taking market share away from New York. Do you really think that the floor traders in the funny jackets are going to be around much longer?

Posted by: bkborn at March 1, 2006 5:32 PM

Much of the "FI" work in "FIRE" can just as easily be done in Georgia or Bangalore and is increasingly moving to such locations. As for the "RE" in "FIRE", its an interesting argument to say that Real Estate will not depreciate because the local economy is driven by Real Estate. Indeed it is, and perhaps too much so.

Posted by: GrandPa at March 1, 2006 6:39 PM

FYI in New York Magazine a nice bit about rents in Manhattan. Seems everyone renting while waiting for the bubble to burst has lead to a 1% vacancy rate in downtown Manhattan. As a result rents in Peter Cooper Vill. are going up as much as 25%. And every .25% in intrest on a 30 year 600K loan means an extra 220K in payments. Looks like a lose lose to me.

Posted by: Anonymous at March 1, 2006 8:03 PM

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