Do You See a Bubble?

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Do you see a bubble, dear reader?

Housing prices in certain areas of the country are definitely in bubble-mode. They are rising at an unreasonable and unsustainable rate.

People don’t ask questions when prices are rising. But if they did they’d want to know why a house is worth twice as much in 2005 as it was 10 years ago…how it is possible for house prices to grow faster than GDP, inflation and incomes…and what happened around the turn of the century that caused house prices shoot up faster than they have done in the last 50 years?

We grew up near one of the biggest growth industries of the 20th century — the U.S. federal government. In the 50s, Washington, DC was far away. But it was growing fast. By the 1970s, the Washington suburbs had spread out through Prince Georges County all the way to the Chesapeake Bay. And by the 1990s, it seemed like everyone in the area was connected to the federal government in some way.

We didn’t know it at the time, but Washington was becoming the political center of a huge empire — the world’s only real hegemon of the late 20th century and early 21st. Naturally, property prices rose — as the area attracted hustlers, hangers-on, and hacks not only from all over the nation, but from all over the world. Every minor country and major industry wanted a presence in the imperial capital.

Property prices grew along with the empire. But never spectacularly. When a city stretches out around its center, its buildable surface area expands by the square of the distance from downtown. The outer circles of growth are many times bigger than inner ones. So the supply of housing easily keeps up with demand — unless it runs into a physical barrier, such as the Hudson and East rivers around Manhattan and the mountains hemming in Aspen, Colorado.

But even though builders are putting up thousands of new houses all around the Capital Beltway, prices are now running up as much as 10 times faster than real GDP growth. This phenomenal inflation of house prices only began after 2001. Part of it could be caused by George W. Bush’s big boost of spending. After years of relative decline during the Clinton administrations, for example, military spending is soaring. So is domestic spending. This spending puts more money into the local economy.

But a larger cause almost certainly comes from the Fed’s “emergency” level interest rates. The original emergency was trying to get the U.S. economy out of its 2001 slump. The recession ended with the New Years’ parties of 2002. Mr. Greenspan has since raised rates — but they are still at or below real rates of inflation. Which is to say, the Fed is still giving away money.

A bank may take the money directly. But an individual cannot borrow directly from the Fed. Still, he can take advantage of the Fed’s apparent generosity by refinancing his present house or buying another one. This is the gas that is causing the nation’s property bubble.

If they were in the mood to ask questions, people might also wonder what the emergency is now? Why doesn’t the Fed “normalize” rates?

The maestro edged towards this question recently in unemotional terms. He referred to a “conundrum.” Specifically, he wondered why long bond yields were falling, even as he pushed up short ones. He did not mention it, but he might also wonder why employment numbers are still disappointingly low.

Our guess is that the Fed chief sees a new emergency — trying to undo the damage from his last emergency operation. Cutting rates so low for so long Mr. Greenspan turned a slump into a residential property bubble. If he were to “normalize” rates, the bubble would pop. Then comes the real emergency.

Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century.

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