Friday, May 27, 2005

The housing market--what will kill the boom?

At Berkshire Hathaway's shareholder meeting earlier this month, Warren Buffet commented on the housing market:
People go crazy in economics periodically, in all kinds of ways. Residential housing has different behavioral characteristics, simply because people live there. But when you get prices increasing faster than the underlying costs, sometimes there can be pretty serious consequences.
So much has already been said, written, predicted, speculated and surmised about the possibility of a "bubble" in housing, why not add even more rhetorical kindling to the fire? Here goes.

The most widely held belief has been that higher interest rates would bring about the demise of the boom. But Greenspan's Fed has tripled short-term rates in their last eight meetings and long-term rates have barely budged. So, if mortgages stay cheap, could the bubble still burst?

UCLA economics professor Edward Leamer believes such a scenario is already in the works: a flattening yield curve.
With long-term rates as sluggish as sea cows and Greenspan & Co. relentlessly raising short term rates, the gap between the two has tightened to nearly nothing. When the spread was very wide, banks raked in profits by borrowing at super-low short-term rates and then lending at high long-term rates. When the spread narrows, their margins get pinched, and they have less incentive to lend. Also, they have less extra cash to cover defaults, so they scrutinize new borrowers more carefully.
Fewer borrowers mean fewer buyers, and you don't need a UCLA economics professor to figure out the rest.
There are so many similarities between the housing market of '05 and tech stocks in early 2000. Are we headed for a bust? Is there anything we can do to stop it?

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