Economist : Global Housing Prices - Danger in the USA?

A home-grown problem - Global house prices
10 September 2005
The Economist

America's housing boom is causing an enormous misallocation of resources

THE past few years have seen simultaneous housing booms in an unusually large number of countries. However, according to The Economist's global house-price indices, in the second quarter of this year the pace of increase slowed in most places, compared with a year ago (see table). In only two of the 20 countries covered have prices accelerated significantly this year: the United States and Denmark.

The sharpest drop in annual house-price inflation over the past year has been in Britain (from 19% to 2%). Australia, New Zealand and South Africa have also seen a marked slowdown: Australian prices have even fallen, if only by 0.1%. Housing markets in Spain, France, Italy and Ireland have also cooled a bit.

By contrast, America's housing market remains red hot. Average home prices jumped by 13.4% in the year to the second quarter, the biggest rise in 26 years—in real terms, the biggest on record. Prices are now rising at a double-digit pace in 24 states, plus Washington, DC. Seven states and the capital enjoyed gains of more than 20%.

Even Alan Greenspan, the chairman of the Federal Reserve, now seems to agree that American homes look overvalued and that there is a risk that prices could fall. A common counter-claim is that house prices are sticky downwards: the national average has never fallen year-on-year. But declines are far from rare in many parts of the country. Richard DeKaser, the chief economist at National City, a Cleveland bank, has found that in the past 20 years as many as 63 out of 299 metropolitan areas studied have seen house prices fall by 10% or more over periods of at least two years. The median decline during these slumps was 17%. This is the first time that booms—and hence potential busts—have occurred in so many states at once.

The popular argument that high house prices are justified by low interest rates has also been stretched to its limit. The affordability of houses for first-time buyers, measured by the ratio of median income to median mortgage payments, is at its most daunting since 1989—the market's previous peak, after which average nationwide home prices failed to keep pace with inflation for five years.

On the surface, America's housing boom looks more modest than those elsewhere. Since 1997 prices have risen by only half as much as in Britain. On the other hand, the property boom has probably caused a bigger misallocation of resources in America because of the response of borrowers, savers and investors. Residential investment has risen to 6% of GDP, close to a record. Add in the wealth effect from rising home values and the boost to spending from mortgage-equity withdrawal, and housing accounted for an astonishing 50% of GDP growth in the first half of this year, reckons David Rosenberg, chief economist at Merrill Lynch. Since 2001 more than half of all private-sector jobs created have been in housing-related industries.

Second-quarter figures, due later this month, are likely to show that the value of property rose to 33% of households' total assets—the highest in the 60 years for which data exist. Banks' profits have also been unduly dependent on mortgage lending. According to the Bank Credit Analyst, a Canadian research firm, property loans now account for 53% of banks' total lending, up from 30% two decades ago.

The American economy's addiction to housing leaves it exposed not only to a cooling of property prices, but also to long-term costs. The technology bubble in the late 1990s at least left behind a modern capital stock, which continues to yield productivity gains; a property boom, in contrast, does nothing to boost long-term growth. Instead, it diverts resources away from more productive sectors and by fuelling consumer spending it exacerbates America's economic imbalances. Eventually, there will be a price to pay.>