The Last Great Bull Market

One surprising aspect of this surprising economy is housing. About 18 months ago, neighbors of mine sold their home for about 25 percent more than I thought--in my wildest imagination--it was worth. At the time, I congratulated them. They had sold, I suggested, exactly at the peak of the real-estate market. Wrong again. A few weeks ago, another house a few blocks away went for about 20 percent more than I thought--in my wildest imagination--it was worth. Housing, it seems, is the last bull market.

It's not just my neighborhood. The National Association of Realtors reports that in 2001 the median price of existing homes rose 6.2 percent to $148,000. In Nassau and Suffolk counties outside New York City, the gain was 23.2 percent to $269,900. In the Minneapolis-St. Paul area, the jump was 22.3 percent to $172,800. In Los Angeles, the increase was 12.6 percent to $254,300. The NAR surveys home-sale prices in 120 metropolitan areas. In 2001 only 11 showed price declines. The largest drop was 3.7 percent.

To anyone with a sense of history, the home boom must be a source of wonder. Housing usually leads the economy into recession. Mortgage rates rise, then housing construction and home sales fall. In the recessions since 1960, the decline of home building has cut an average of almost 1 percentage point from gross domestic product. Not this time. In 2001 new-home construction totaled 1.603 million units, up 2.2 percent from 2000. Existing home sales set a record of 5.25 million, almost 3 percent higher than in 2000.

Americans are, well, being American. They're exercising their faith in the future. If they don't own a home, they want one. The homeownership rate--the share of households not renting--is now a historic high of 68 percent; in 1990 it was 64 percent. Those who already own want to "trade up." On average, Americans' homes are expanding while their yards are shrinking. Since 1987 the size of the median new home has grown 17 percent to 2,059 square feet, while the size of the median lot has dropped 6 percent to 8,750 square feet, according to the National Association of Home Builders. In 1987 only 23 percent of new homes had four or more bedrooms. By 2000 about 35 percent did.

"We've seen housing perform an heroic role in fighting off recession," says economist Todd Buchholz, author of a new report ("Safe at Home: The New Role of Housing in the U.S. Economy") from the Homeownership Alliance, a group that promotes affordable housing. It's more than construction. Home buyers, says Buchholz, spend $6,000 to $9,000 on extras: linens, mattresses, sofas, lawn mowers, televisions, stereos, fences, garden furniture.

Buoyant home prices have also fortified national morale by neutralizing some of the gloom from growing unemployment and a falling stock market. There's been a Wal-Mart effect: the middle class has benefited the most, because its wealth is most concentrated in housing. By contrast, the wealthy and well-to-do are more invested in Wall Street. From year-end 1999 until last September, household stock wealth--mutual funds and directly owned shares--lost about $4.4 trillion in value, dropping to $8 trillion. Almost half the loss was offset by higher home values, up $2 trillion to nearly $12 trillion over the same period.

The explanation of why, this time, housing defied the business cycle lies mainly in interest rates. In January 2000, 30-year fixed-rate mortgages averaged 8.2 percent. A year later they were 7 percent, which is where (generally speaking) they've stayed. People rushed to buy. Lower rates also prompted massive refinancings of existing mortgages. This reduced monthly payments or allowed some borrowers to convert increased home values into cash. In 2001, these so-called mortgage cash outs raised consumer spending by $50 billion, estimates economist Orawin Velz of Fannie Mae.

Housing has also profited from the efforts by Fannie Mae and Freddie Mac--the nation's largest mortgage lenders--to expand homeownership among blacks, Hispanics, immigrants and low-income families. Since the mid-1990s, down-payment requirements and credit standards have been eased. Homeownership rates have increased from about 42 percent for blacks and Hispanics in 1995 to almost 49 percent last year. (For whites, the gain was from 71 percent to 74 percent.)

For a faltering economy, all this has been a godsend. But inconvenient questions arise. Is housing's bull market genuine? Or is it another "bubble"?

One skeptic is economist Ian Morris of HSBC Securities. Housing's boom, he says, partly reflects the stock market's bust. Disenchanted investors shift funds into homes, which seem safer. In a weaker economy, lenders also prefer home loans to business loans; so mortgage rates drop. Easier credit and strong buying then boost home prices--too fast. "We've witnessed this process elsewhere in the world," says Morris. "The stock market will peak before the property market." In Japan, the stock market "peaked in December 1989, and the real-estate market kept rising for another 12 months."

Morris calculates that all homes are now worth about 1.6 times Americans' disposable personal income--a ratio virtually identical to the record in 1989. For five years after that, modest gains in home prices lagged behind inflation. "The current rate of price increases is unsustainable," he says. "The best we can hope for is a soft landing of prices." Mortgage delinquencies are also rising. In September, 4.87 percent of loans were 30 days or more overdue--the highest level since 1991. This is exactly what you'd expect in a recession, especially after a long boom when borrowers and lenders became overconfident.

The hints here are that housing's next surprise might be unpleasant. But they are just hints that, as yet, are nowhere evident in my neighborhood. Just last week a home down the block went on the market. A few days later, there was already an UNDER CONTRACT sign out front. When I learn the price, it will no doubt seem shockingly high.