The rapid rise in U.S. home prices, increasing almost 50 percent overall over the last five years, has created a hot-button debate over whether Americans are staring at a possible home-price collapse.
The growth in home prices over the past year surpasses any increase in the last 25 years, according to data released by the Office of Federal Housing Enterprise Oversight, which tracks average quarterly house-price changes. Some economists have raised an eye to this unprecedented run-up in prices, saying it may be cause for concern.
In evaluating what the recent housing boom could mean for the nation’s homeowners, the FDIC in a report titled, “U.S. Home Prices: Does Bust Always Follow Boom?” attempts to define housing booms and busts and considers what causes them. The FDIC finds that while home-price booms cannot sustain forever, not all booms end in busts.
Sixty-three U.S. metropolitan areas experienced at least one housing boom since 1978, and 24 cities experienced more than one boom, according to the report. The FDIC defines a “boom” as a 30 percent or more increase in inflation-adjusted home prices during any three-year period.
“Geographically, home-price booms have been concentrated in cities in California and the Northeast, which account for almost 70 percent of our 63 boom markets,” the report states.
The FDIC defines a “bust” as an inflation-adjusted price decline of 15 percent or more in five years. Using these criteria, some 21 cities were found to have experienced a housing bust at some point over the last 25 years.
The report identifies two “major episodes” of home-price busts, the first taking place in the mid-1980s in the “oil patch” cities of Texas, Oklahoma, Louisiana and some other western states. This episode had some of the most severe price declines found in the report, with prices in one city falling by as much as 40 percent over a five-year period.
The second incident of major price declines occurred in the Northeast and California in the early 1990s.
The report notes that no cities are currently experiencing home-price busts. However, judging by historical events, we won’t know for a few years whether the recent post-boom cities have safely avoided a bust.
And according to the report’s criteria for booms and busts, home-price booms “only infrequently” lead to busts.
Busts within a five-year window of booms only occurred in 9 of the 54 boom episodes identified prior to 1998, or roughly 17 percent of all such events. “Clearly, the lion’s share of home-price booms have not ended in busts historically,” the report states.
That leaves 45 booms that did not see a subsequent bust, according to the report.
“In these cases, nominal home prices rose by an average of 2 percent per year during the five years after the boom ended. The equivalent figure for real home prices was a modest 2 percent per year decline,” the report states.
In 83 percent of the post-boom cities, prices continued to increase at a slower rate and any declines after inflation were modest, according to the report. “Home prices in these markets simply stagnated, or stalled out, following their booms rather than going bust.”
Housing booms that have ended in price busts were associated with localized economic stress, including recession and job loss.
The FDIC noted two case studies to illustrate this point, including the case of the oil patch cities in the mid-’80s, and the busts seen in California and the Northeast in the early ’90s.
In the case of the oil patch cities, oil-producing areas of Texas, Oklahoma, Louisiana, Colorado, Wyoming and Alaska experienced an economic boom and population inflows while oil prices were rising in the late 1970s. That, in turn, caused the demand for housing to boom in these areas, increasing home prices. Then in 1980, when oil prices began a six-year decline, the local job markets and economies suffered.
“This economic stress, in turn, weighed heavily on the housing markets in these cities. In the worst cases, nominal home prices fell by 40 percent and 33 percent in Lafayette, Louisiana, and Casper, Wyoming, respectively, between 1983 and 1988,” the report states.
In the case of California and the Northeast, similar elements of economic stress precipitated home-price busts, according to the report. A recession in the early 1990s, massive defense downsizing, a significant commercial real estate collapse, and a sharp downturn in population growth all were factors.
Although the FDIC demonstrates that few metro-area housing booms have ended in busts historically, the report notes reasons to believe history may be an imperfect guide to today’s situation. It notes changes in credit markets, such as the emergence of the subprime market, that are pushing homeowners and housing markets into uncharted territory.
In addition, home buyers increasingly are taking advantage of higher-leverage mortgage products. In 2003, loans exceeding 80 percent of the home price accounted for almost one-third of all purchase mortgages. The practice of raising the total loan amount to a level very near the value of the home makes borrowers more likely to default if there is a housing market downturn.
“An increased incidence of default and foreclosure could, in turn, contribute to downward pressure on home prices as distressed properties are liquidated by lenders. However, little is known as yet about the effects these credit-market changes might have on the dynamics of boom-bust cycles,” the report states.
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