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What’s the Worry? Housing Bubble Concerns Unjustified in Current Recovery

Housing Prices Haven’t Peaked in Most Markets; Affordability Still High
January 6, 2014
Only a few days into the New Year and already we’re hearing worries about a bubble in the recovering U.S. residential housing market. It seems that some analysts can’t go one year without an overhanging fear of catastrophe.

While most cities are seeing continual, albeit slow growth in housing prices, recently several cities across the country have seen housing prices climb back to reach all-time highs, which sparked the latest round of concerns.

However, according to Don Frommeyer, president of The National Association of Mortgage Brokers (NAMB), the cities with peaking housing prices seem to be the exceptions across the country.

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“Most areas are still seeing housing prices with numbers well below their highs in 2007. It’s the areas that were mostly unaffected by the housing crash that are seeing the high numbers, they didn’t have as far to climb to reach peak numbers,” Frommeyer said. “Overall, the housing prices are still below the high values nationally. While most areas aren’t above their previous peak prices, they are still experiencing increases to an extent, which is a continuing sign of the housing recovery."

Frommeyer cited statistics from Zillow that showed most cities across the country have gained back about 10% to 15% in value from the 23.8% plunge in average US housing prices from 2007 to 2011.

Cities that have seen housing values climb back to reach their previous highest average include Oklahoma City, Denver and select areas within the Bay Area and the Pittsburgh metropolitan area.

S&P: Why Bubbles Aren’t as Dangerous Today

According to Standard & Poor’s, publishers of the monthly S&P/Case-Shiller Home Price Indices, the rebound in U.S. home prices are sparking fears of another round of bubbles among many investors and market pundits.

“While we don’t know the chances that either stocks or home prices will plunge in 2014, the collateral damage from either will be less than it was in 2008 because the underlying leverage in the economy is substantially smaller today than it was back then,” the rating agency reported this week.

The financial crisis was a two-step (or double dive) event, according to S&P. First home prices collapsed, wiping out about a third of the value of American homes. Second, a lot of the mortgage debt collateralized by those homes failed creating a cascade of defaults and foreclosures. The higher the loan to value ratio on a home with a mortgage, the smaller the price drop needed to put the mortgage under water, S&P noted. When home prices plunged, homeowners and their mortgages were vulnerable.

Today conditions are improved - the economy-wide loan to value ratio is down to 49%, not as comfortable as 10 years ago, but better and safer for the economy than just before the financial crisis, S&P noted.

This reduction in personal debt did not simply happen. Rather, the appetite for borrowing and debt is much less today than seven years ago, the firm added.

However, S&P said, while the lower leverage and debt overhang make a bubble in housing values much less likely, it doesn’t mean stock prices or home values can’t slide or that we shouldn’t be concerned that some markets may be over-valued. The lower debt and leverage simply means there will be less damage if markets fall.

"That alone should ease some fears as we start a new year with higher prices on houses and stocks,” according to the ratinigs agency.

Housing Outlook

Meanwhile, the housing price recovery of 2013 is already starting to lose steam as Americans remain cautious about their personal finances and the state of the economy, according to Fannie Mae’s latest National Housing Survey results.

Among those surveyed, nearly two-thirds said they believe the economy is on the wrong track while the share expecting their personal finances to worsen during the next year has increased during the past few months to 22%.

Meanwhile, consumers’ home price expectations have declined steadily since summer. The share who say prices are going to increase within the next 12 months fell to 45% and the average home price change expectation dipped to 2.5% from 2.9%. In addition, the share of those who expect mortgage rates to climb in the next 12 months has remained at an elevated level since it spiked in June.

“In this environment, the housing recovery is likely to improve, but only at a gradual pace,” said Doug Duncan, senior vice president and chief economist at Fannie Mae. “The majority of consumers expecting higher mortgage rates implies a slowing of housing market momentum. As the economy continues to improve and household balance sheets for most Americans are slow to repair, we continue to see the transition to a full housing recovery as a slow process.”

According to Freddie Mac Chief Economist Frank E. Nothaft, “Despite rising mortgage rates and continued property-value appreciation, housing will remain generally affordable in most parts of the country. With household formations expected to pick up and new home completions gaining more slowly, for-sale inventories may remain tight.”

With housing located in large metro areas along the Atlantic and Pacific coasts are already expensive for the typical family, rising interest rates are expected to have a bigger effect there. "But in most of the country, incomes and home prices are such that rising rates by themselves will not be enough to end the recovery. What we need is some better income growth,” Nothaft said.

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