An Overblown Bubble

It's rare that Alan Greenspan, the man who guards the sanctity of the dollar, speaks in Congress on a subject that most Americans understand and truly care about. He did last week when he addressed real estate.

Freddie Mac, a major provider of the money for mortgage lending, just reported that home prices rose at an annual rate of 9.6 percent in the first quarter of the year.

The big question on America's collective mind is whether there's a bubble--that is, have home prices, driven by the low cost of borrowing (the average 30-year mortgage is just 5.56 percent), soared so much that, like the prices of high-tech shares in 2000, they will come crashing down?

Greenspan said that he didn't think there was a national bubble but that "signs of froth in some local markets" had appeared.

A recent study of 142 metropolitan areas by concurs. It compared actual prices with what the local market should have been able to bear based on personal income, interest rates, building costs and supply.

U.S. housing, on average, turned out to be overvalued a bit, but some specific markets were "highly overpriced," including (in order) Las Vegas, Washington, D.C., West Palm Beach-Boca Raton, Fla., and, in California, Riverside-San Bernardino and Sacramento.

Still, while financial bubbles do occur, it's highly risky--often an act of hubris--to claim that market prices are somehow too high or too low. Home prices, like stock prices, are set by thousands of buyers and sellers with real-live money in the game. Sure, they can be wrong, but I prefer a more modest view: assume that markets know more than professors and bureaucrats.

Also, remember that housing markets aren't stock markets. When tech stocks started to fall, investors panicked and dumped their holdings, but, even if the prices of new houses decline sharply, most homeowners won't sell their dwellings at a loss. They live in them! The value at any moment doesn't matter. In addition, high transaction costs--sales commissions plus transfer taxes--put a damper on rapid turnover of homes.

The truth is that average U.S. home prices have been remarkably stable over time. Since 1950, they have never declined over the course of any year. By contrast, the broad stock index has fallen 12 times in that period; the bond market, 17 times. But don't expect to make a mint off your house. Between 1975 and 2003, average home prices rose an annual average of less than 1 percent after inflation in 29 states, and between 1 percent and 2 percent in 11 others.

But there are legitimate concerns. First, in upscale markets particularly, rental prices are way out of whack with home prices, indicating that buyers are expecting big future appreciation, which could be a pipedream. In Washington, for instance, a condo that costs $600,000 will be fetching a monthly rental of $2,500 or less. That's a return of less than 4 percent annually after expenses--or about what you could get with a medium-term Treasury bond.

Second, Greenspan frets about froth in the mortgage markets, including "the dramatic increase in the prevalence of interest-only loans"--which accounted for more than 40 percent of mortgages in such markets as San Diego, Denver and Atlanta last year--and of "exotic forms of adjustable-rate mortgages."

Such mortgages tend to require low payments in the early years and high payments later. I don't think they're necessarily so risky--especially for young people whose earnings are likely to rise as they get older.

Most Americans make good choices about their own finances. Household balance sheets are strong, reports David Malpass of Bear Stearns. The concern for policymakers should be lending institutions: are they making bad loans that might lead to system-wide failures and an expensive government bailout?

Here, the worry isn't most mortgage lending. After all, owner equity is 56 percent of the value of the average house today, down only a bit from the 58 percent registered in 1994. And, unless Congress does something reckless to hobble them, Freddie Mac and Fannie Mae will continue to provide liquidity and stability, a key backstop.

Besides, economic catastrophes rarely occur in markets that everyone is watching and sweating over. My own worries focus not on home mortgage but on the highly speculative trading practices of giant lenders and on their commercial loans, at home and abroad.

That should be the subject of Greenspan's next jeremiad.

James K. Glassman is a resident fellow at AEI and host of the Web site

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About the Author


James K.
  • James K. Glassman is a visiting fellow at the American Enterprise Institute (AEI), where he works on Internet and communications policy in the new AEI Center for Internet, Communications, and Technology Policy.

    A scholar, diplomat, and journalist, Glassman rejoins AEI after having served as under secretary of state for public diplomacy and public affairs, during which time he led America’s public diplomacy outreach and inaugurated the use of new Internet technology in these efforts, an approach he christened “public diplomacy 2.0.” He was also chairman of the Broadcasting Board of Governors, the independent federal agency that oversees all US government nonmilitary international broadcasting. Most recently, Glassman was instrumental in the creation of the George W. Bush Institute, where he remains the founding executive director.

    Before his government service, Glassman was a senior fellow at AEI, where he specialized in economics and technology and founded The American, AEI’s magazine, which he led as editor-in-chief until his departure from AEI in 2007.

    In addition to his government service, Glassman was a former president of The Atlantic, publisher of The New Republic, executive vice president of US News & World Report, and editor-in-chief and co-owner of Roll Call. As a columnist for The Washington Post, Glassman wrote about political and economic issues. He was also the host of CNN’s “Capital Gang Sunday” and of PBS’s “TechnoPolitics.” In 2000, he cofounded TCS, a technology and policy website. His most recent book is “The Secret Code of the Superior Investor” (Crown Forum).

    Glassman has a B.A. in government from Harvard College where he was a managing editor of The Crimson.


  • Email: [email protected]

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