Housing Busts Don’t Inevitably Follow Booms
The nation’s housing boom continued to expand to more cities last year, according to a May 2 update to a report by the Federal Deposit Insurance Corporation (FDIC), and if the boom is heading towards a conclusion it is more likely that those markets will see their home prices stagnate rather than go bust. At the end of last year, there were 55 boom markets, which are defined as those where housing prices have risen by at least 30% over inflation in a three-year period, according to the new information added to the FDIC study, “U.S. Home Prices: Does Bust Always Follow Boom?” That was up 72% from the 33 metropolitan areas that were booming in 2003. Looking at the house price index published by the Office of Federal Housing Enterprise Oversight (OFHEO), the FDIC report found that 14% of the 362 metro areas for which there was price data were booming. This represented the highest proportion of boom markets nationwide in the 30 years of historical price data from OFHEO, but it was similar to the boom conditions that prevailed in 1988, when 11% of 215 cities, or 24 markets, were experiencing a boom. About 91% of last year’s boom cities were located on, or near, the East and West Coasts, “where land constraints and more dynamic economies have led to greater swings in coastal home prices over the past 30 years,” according to the FDIC. At the peak of the 1988 housing boom, all of the boom cities were in either California or the Northeast. Of the 31 cities identified as boom markets in both 2003 and 2004, all but three continued to see rising cumulative home price increases in 2004. The exceptions were Boston; Stockton, Calif.; and Wooster, Mass. During 2003, housing in boom markets had an average three-year real price gain of 37%, more than twice the national average of 17%. Last year’s boom cities saw a three-year gain of 42%, versus 20% nationwide. Of the 24 boom markets that were added to the list last year, only six had ever experienced a boom previously. The report notes that local factors typically are responsible for boom markets, but that national factors could be helping to drive home prices higher. “If national factors are coming more into play, then clearly the most important factors to look to would be the availability, price and terms of mortgage credit.” The low cost of mortgage credit, an increase in high loan-to-value and subprime lending and an increase in the use of adjustable-rate mortgages and interest-only mortgages have helped to expand the boom, the report says, with the implication that a rise in mortgage interest rates and a tightening of lending standards could contribute to an end to the boom. The report also cites an increase in home purchases by investors that could make any downtrend in home prices worse because “academic studies show that residential property investors are less loss-averse than owner-occupants and thus more likely to sell precipitously in a declining market.” When the boom does end, there is no need to assume the worst, according to the report. “In over 80% of the metro-area price booms we examined between 1978 and 1998, the boom ended in a period of stagnation that allowed household incomes to catch up with local home prices. While neither lenders nor current home owners particularly like stagnation in home prices, such an outcome represents a necessary adjustment in market conditions that helps bring home prices within the reach of new home buyers.” Only 17% of the local housing booms identified between 1978 and 1998 were followed by a bust, the FDIC study says, “and where busts occurred they were typically preceded by significant distress in the local economy. To the extent that local factors continue to determine home prices trends, the expectations would be that metro-area home prices busts will continue to be relatively rare.” | 
