May 27, 2005

Spitshine Speculators

In a recent piece, Running Out of Bubbles, Paul Krugman offers some of the most chilling words to date on the housing market in the US. First, Krugman briefly touches on the second edition of "Irrational Exuberance" by Robert Shiller. Shiller, who correctly called the stock bubble of the late 90s, claims that the housing bubble "may be the biggest bubble in U.S. history". Krugman goes on to provide some stark statistics: "..the National Association of Realtors estimates that 23 percent of the homes sold last year were bought for investment, not to live in. According to Business Week, 31 percent of new mortgages are interest only (buyer pays no principal), a sign that people are stretching to their financial limits." Interest only loans account for more than half the market in California.

So real estate is dangerously inflated (particularly in, of all places, the Bay Area). But what could actually pop the bubble you might wonder. The answer is that the well of cheap money would have to dry up. And the biggest factor in determining the amount of cheap money (i.e. mortgage rates) are rates on long-term US Treasury bonds. The Economist recently provided some anecdotal evidence that the great free lunch may be coming to an end: "For the first time since August 2003, in March foreign central banks were net sellers of Treasury bonds and notes, according to American government data released on May 16th."

If foreign banks stop buying US bonds, we'll be in big trouble as interest rates could skyrocket. Ultimately, all this might greatly benefit first-time home buyers who are currently priced out of the market. Definitely worth watching this one carefully as it plays out.

Posted by dr_v at May 27, 2005 04:48 PM

I'm still not going to hold my breath in hopes of being able to afford a Bay Area home anytime soon. Somehow someone will think of a way to keep prices artificially high forever, because people who talk about the importance of home ownership sure aren't talking about the interests of first-time home buyers, but rather the old richies hanging onto their homes that are now too big for them.

Posted by: Kristina on May 28, 2005 09:28 PM