Bubble intact despite high house prices

Ground Floor: Only a few days before Ben Bernanke was nominated to succeed Alan Greenspan as US Fed chairman, he testified to Congress that the US didn't have a housing bubble and that it wasn't about to burst.

According to Bernanke, the fact that house prices in the US have risen by around 25 per cent over the past couple of years can be put down to "strong economic fundamentals" and that, in any event, they weren't likely to keep rising at that rate. In these comments, he was echoing Greenspan who also doesn't see any signs of a bubble, although he did concede a touch of "froth" about housing prices.

Greenspan and Bernanke agree that it's not possible for the Fed to identify a bubble anyway. Speaking at a Fed symposium in Jackson Hole in 2002, Greenspan argued that only the bursting of a bubble confirmed its existence in the first place and that, even if it could be identified, it was far from obvious that anything could be done about it - unless the central bank engineered a "substantial contraction in economic activity" which, of course, is what it would realistically want to avoid.

He did, however, agree that there were "characteristics of bubbles" in certain areas, although not nationwide. House price inflation, in some areas of the US, is running at double or triple the national rate, according to the National Association of Realtors, particularly on the east coast, Las Vegas and California.

Now though, the US market overall is getting a little less certain. There has been a downturn in the speed of selling some of the higher priced properties. All of a sudden, mortgage applications are down, while the average rate on a 30-year mortgage, at 6.31 per cent, is now at its highest in nearly a year and a half - proof that the quickest way of slowing down prices is by hiking up interest rates.

Central bankers don't really like talking about the housing market. Not everyone has a direct holding of equities or bonds, nor do they watch market reports every evening. But almost everyone takes an interest in the housing market, and the thought of higher rates and a sudden collapse in prices can petrify homeowners.

This is why there was a whiff of panic among Irish citizens with last week's report from the Organisation for Economic Co-operation and Development (OECD) implying that housing prices are overvalued by 15 per cent and that the Central Bank advised that a "numerical estimate of overvaluation" should be presented with caution to avoid destabilising the market. It was the suggestion that the bank wanted somehow to keep a lid on the 15 per cent overvaluation estimate which set off the spate of nervous chattering, not that there was an overvaluation in the first place. In any event, the bank denied the "extreme caution" comment, and the OECD has accepted that the bank might not have used the words. Everyone breathed a sigh of relief and turned to the property supplements again.

Not that overvaluation reports really matter. Everyone and his dog knows that property prices in this country are probably overvalued. Most people would be sanguine about a mere 15 per cent correction over a few years if that was what was going to happen, given that we've been assailed with estimates of overvaluation which have ranged from 5 to 40 per cent in the past. The Economist magazine is still the butt of jokes from Irish homeowners for its comments about Irish house prices.

Almost all housing analysts are agreed that it would take a cataclysmic event to cause a house price crash, but that we should be prepared for a soft landing on prices in the future. We have, of course, been preparing for the soft landing for at least five years now. Estate agents argue that there is still a strong demand for property in the country and that this demand will continue to underpin prices.

They're right - at least for as long as interest rates remain at current levels. However, economists are suggesting that the European Central Bank might be ready to increase its base rate from the 2 per cent low it has been at for the past two years. And that, more than talk of overvaluations, is what could ultimately have the greatest impact on prices.

According to a Central Bank report last year, first-time buyers are more indebted now than they were 10 years ago, with repayment burdens of 27.1 per cent of net income in 2004 versus 23.7 per cent in 1995.

That burden, though, was higher in the early 1990s and householders weathered that storm thanks to stable low interest rates and the very house price inflation that the authorities are so squeamish about now.

Predicated increases of a quarter of a percentage point will hardly panic the market. Even if there are two of them over the next six months. The likelihood is that we will continue on our merry way, aware that our houses are probably overvalued but accepting it. Buyers will just load up the borrowing wheelbarrow and buy their dream home in the expectation that, in a few years, it will be worth a lot more. And why should they think otherwise?

Earlier this year, US representative Scott Garrett told Greenspan that he was buying a house in Washington, but that he was convinced the bubble would burst as soon as he paid for it. We've all felt that way, but so far, the fundamentals have kept us (and Scott) out of trouble.

[ www.sheilaoflanagan.net ]