NEWS: Booming Local Housing Market

Weigh Heavily on Overall Sector

By GREG IP

Staff Reporter of THE WALL STREET JOURNAL

June 20, 2005; Page A1

New federal housing data show that the nation's most overheated local housing markets now make up such a large share of the total U.S. market that a sharp fall in their values could stall or slow national economic growth.

The 22 major metropolitan markets with the fastest-growing house prices account for 35% of the value of the nation's residential real estate, but just a fifth of its population, says the Federal Deposit Insurance Corp.

Their share of the national real-estate market has risen quickly. In 2000, the 22 markets accounted for 27% of all U.S. residential real estate. In 1995, the figure was just 24%.

Some economists say local bubbles are less worrisome than a nationwide one because they are more likely to pop individually, in response to local events, reducing the national fallout. And Federal Reserve Chairman Alan Greenspan recently has said that the U.S. has no national housing bubble, but there are "signs of froth in some local markets."

But the latest data suggest that real-estate values in the nation's fastest-growing markets are getting so large that the distinction between them and the national market could become meaningless.

"It's a widespread boom and has macro implications," says Richard Brown, chief economist of the FDIC. "A slowdown would not only hurt these markets, but the U.S. as a whole." (See related article1.)

Says Mark Zandi, chief economist at Economy.com, a consulting firm specializing in regional economic analysis, "If you tote up the metropolitan areas that are bubble-like, it's closing in on half the housing stock. Another year of these price gains and I think it would qualify as a national house price bubble even though not every corner of the country is experiencing speculative activity."

The FDIC considers a local market to be a boom market if it has appreciated 30% or more, adjusted for inflation, in the past three years. It says 55 of the country's 362 local metropolitan markets qualified in 2004. Together, they accounted for roughly 40% of all the value of residential real estate in the country -- up from about 30% in 2000.

The agency has detailed data for only 22 of those 55, though they include most of the largest and among the priciest of those 55 markets. The two largest metropolitan areas, New York and Los Angeles, each have a value of more than $1 trillion. Adding in the Boston, Washington, D.C., and San Diego metropolitan areas, the top five boom markets are valued at $4 trillion, or 24% of the national total, while those markets represent just 12% of the U.S. population of 294 million.

FDIC economists prepared the local estimates at the request of The Wall Street Journal. The FDIC is an independent federal agency that provides insurance for most bank deposits and regulates state-chartered banks that aren't members of the Federal Reserve system.

The disproportionate concentration of housing wealth in a few markets is reminiscent of how a few technology and blue-chip companies drove the bull and bear markets in stocks starting in the late 1990s.

The Standard & Poor's 500-stock index rose 45% from the end of 1997 to February 2000, but the average stock rose just 14%. Over the next three years, as technology companies plummeted, the index fell 36%, but the average stock fell just 2%, according to Aronson+Johnson+Ortiz, a Philadelphia money manager.

At the same time, houses are unlikely to fall anywhere near as sharply as stocks can. That's because it's costly for families to move, and sellers are more likely to take a house off the market if they can't get an acceptable price.

If the 55 boom markets declined 15% while the rest of the country was flat, national housing prices would drop 6% -- on a par, adjusted for inflation, with previous national housing pullbacks, but hardly a crash.

Unlike stocks, the housing market "would be more likely flat with 10% to 20% declines in some regions, or down slightly nationally with some regions looking ugly," says Ethan Harris, chief U.S. economist at Lehman Brothers. Even local housing crashes take years to unfold, he says.

Still, a flat housing market could damp overall economic growth by restraining new construction and consumer spending financed by borrowing against home values. Mr. Harris estimates that if the overheated local markets declined 10% a year for three years, while the rest of the country rose 5% a year, it would reduce U.S. economic growth from 4% to about 2.5%.

Federal Reserve officials expect housing prices eventually to level off and restrain consumer spending. But they believe business investment and exports will increase by then and pick up the slack, maintaining overall growth for the U.S. economy.

Though the U.S. hasn't experienced a serious, nationwide decline in home prices in the past three decades, many local markets have fallen sharply. Prices rose sharply in Southern California in the late 1980s, then collapsed in the early 1990s as the economy reeled from a national recession and deep cuts to defense spending.

"Our economy, especially in Los Angeles County, was devastated," says Michael Bazdarich, senior economist at UCLA Anderson Forecast, an economic research center at the University of California at Los Angeles. The defense cuts alone would have caused a serious local recession, he says. But those cuts along with a reversal in home prices "combined to wreak havoc on the local economy." The damage was amplified by mortgage defaults that brought down the region's largest savings and loan institutions.

Mortgage defaults remain low, but a reversal in home prices could change that. Goldman Sachs mortgage analysts say a delinquent borrower in a rising market can use the equity in his home to qualify for a new loan, but loses that option when prices stagnate or decline.

Goldman Sachs studied the experience of Southern California's Orange County, where subprime mortgages -- those issued to less-creditworthy borrowers -- issued in 1992 defaulted at far above the national average, while subprime mortgages issued in 1999, during the current boom, defaulted far less. They estimate that in a region with strong price appreciation now and a subprime default rate of about 1%, several years of declining prices could push defaults to 8% to 10%.

But analysts say even overheated local markets are unlikely to suffer as much as Southern California did a decade ago. The FDIC's Mr. Brown defines a housing bust as a decline of 15% or more, unadjusted for inflation, over five years. For that to happen, he says, "historically, you need severe local economic conditions." The markets where house prices are appreciating the most "are pretty well diversified economies" that don't depend heavily on a single industry like defense or energy, he says.

However, the FDIC cautions that in the past year, national factors such as low mortgage rates and easier lending standards are displacing local factors in driving home prices, so previous experience may be less useful.

Mr. Zandi of Economy.com adds that local housing collapses in New England and Southern California in the late 1980s and early 1990s "infected the broader banking system." Banks today are better capitalized, and thanks to consolidation, less exposed to any single region, he says. Moreover, banks have "securitized" many of their mortgages -- that is, repackaged them as standalone securities and sold them to investors and to federally chartered companies Fannie Mae and Freddie Mac.

But for the same reason, he warns, "No one really has a grip on who has the risk." If something goes wrong in the mortgage market, a lack of transparency could cause investors to shun good and bad borrowers alike, he says.

The low long-term interest rates of recent years are a key factor tying all local bubbles together in the U.S., says Edward Leamer, chief economist at the UCLA Anderson Forecast. If those rates rise sharply, they will "kill off those bubbles all at the same time."

David Lereah, chief economist at the National Association of Realtors, says a local market becomes most vulnerable to collapse when it experiences rapid price appreciation, rising inventories of unsold homes and a high concentration of lending on loose terms, such as interest-only mortgages.

At present, he says, no market is experiencing a "meaningful" rise in inventories -- in fact, the hottest markets tend to have less inventory than average. He says those markets also tend to have the most limited supply of new housing because of land shortages or regulatory constraints.

Booming northeast and California housing markets dominate national real-estate value

Area (Bolding indicates boom market)	Estimated Value (in billions)	Share of U.S. Market*	Share of U.S. Population
Los Angeles-Long Beach CA PMSA	$1,171.4	6.8%	3.4%
New York NY PMSA	1,145.7	6.6%	3.2%
Boston MA-NH PMSA	720.9	4.2%	2.1%
Chicago IL PMSA	631.9	3.7%	2.9%
Washington DC-MD-VA-WV PMSA	562.4	3.3%	1.8%
Orange County CA PMSA	497.8	2.9%	1.0%
San Diego CA MSA	469.8	2.7%	1.0%
San Francisco CA PMSA	350.1	2.0%	0.6%
Nassau-Suffolk NY PMSA	323.1	1.9%	1.0%
Riverside-San Bernardino CA PMSA	311.4	1.8%	1.3%
Philadelphia PA-NJ PMSA	299.2	1.7%	1.8%
Seattle-Bellevue-Everett WA PMSA	242.5	1.4%	0.9%
Newark NJ PMSA	224.1	1.3%	0.7%
Atlanta GA MSA	214.2	1.2%	1.5%
Minneapolis-St. Paul MN-WI MSA	206.4	1.2%	1.1%
Baltimore MD PMSA	202.5	1.2%	0.9%
Phoenix-Mesa AZ MSA	196.9	1.1%	1.2%
Miami FL PMSA	194.8	1.1%	0.8%
Houston TX PMSA	182.1	1.1%	1.6%
Sacramento CA PMSA	179.3	1.0%	0.6%
Fort Lauderdale FL PMSA	172.8	1.0%	0.6%
Denver CO PMSA	171.2	1.0%	0.8%
Dallas TX PMSA	161.3	0.9%	1.3%
Las Vegas NV-AZ MSA	157.1	0.9%	0.6%
Tampa-St. Petersburg-Clearwater FL MSA	153.5	0.9%	0.9%
Portland - Vancouver OR-WA PMSA	137.4	0.8%	0.7%
New Haven-Bridgeport-Stamford-Danbury-Waterbury CT NECMA	135.1	0.8%	0.6%
St. Louis MO-IL MSA	109.2	0.6%	0.9%
Orlando FL MSA	101.7	0.6%	0.6%
Kansas City MO-KS MSA	90.2	0.5%	0.6%
Pittsburgh PA PMSA	89.1	0.5%	0.8%
Cincinnati OH-KY-IN PMSA	78.7	0.5%	0.6%
Indianapolis IN MSA	67.1	0.4%	0.6%
San Antonio TX MSA	61.4	0.4%	0.6%
Total for Largest Markets	$10,012.4	58.1%	39.5%

PMSA = Primary Metropolitan Statistical Area
MSA = Metropolitan Statistical Area

*Based on median values and number of units method

Source: Federal Deposit Insurance Corp.