The Number of Housing Boom Markets Increased Markedly in 2004

This is a follow-up to yesterday's alert. The Federal Deposit Insurance Corporation (FDIC) is talking again about the possibility of a nation-wide real estate bubble in the United States and the most plausible causes and consequences.

" In February 2005, the FDIC released an FYI report entitled "U.S. Home Prices: Does Bust Always Follow Boom?" The article examined the historical pattern of home price booms and busts for U.S. metropolitan areas. This issue of FYI updates the home price analysis from the previous article, using recently released 2004 data for the house price index (HPI) published by the Office of Federal Housing Enterprise Oversight (OFHEO). Based on this index, U.S. average home prices rose by almost 11 percent in 2004, up from 7 percent in 2002 and 2003. Moreover, the number of boom markets according to our definitions increased by 72 percent last year, and now includes some 55 metropolitan areas.
The broadening of the U.S. housing boom during 2004 may imply a growing role for national factors–including the availability, price, and terms of mortgage credit–in explaining home price trends. To the extent that credit conditions are in fact driving home price trends, the implication would be that a reversal in mortgage market conditions could contribute to an end of the housing boom. While history clearly shows that housing booms don’t last forever, the manner in which they end matters for mortgage lenders and borrowers alike.
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The strong nationwide home price performance last year was driven by accelerating appreciation in a number of metropolitan areas. The number of individual markets that met the boom criteria increased by 72 percent in 2004, to 55 metro areas.
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Some 15 percent of the 362 metropolitan areas for which OFHEO publishes the HPI met the boom criteria at year-end 2004. This represents the highest proportion of "boom" markets nationwide in the 30 years of historical price data published by OFHEO.3 The 55 boom markets last year compare to 22 just two years earlier and to only 9 boom markets identified as recently as 2000 (see Chart 1). "



"Prior to the recent surge in home prices, the last time the United States saw a large number of metro areas experiencing housing booms was in 1988. At that time, 24 markets were experiencing a boom. That number was 11 percent of the 215 cities for which home price information is available between 1985 and 1988.
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Through 2003, even as the housing boom extended to 32 metro areas, the most plausible explanation for the observed price trends was the combination of historical price volatility and strong local market fundamentals in boom cities. Almost half, or 47 percent, of the 2003 boom markets had seen other booms prior to 2000. However, of the 24 boom markets added to the list in 2004, only 6 have ever previously experienced a boom in their history. Eighteen markets are booming for the first time according to the OFHEO data and based on our criteria.
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Our analysis of the OFHEO historical home price data shows that metro-area housing booms don’t last forever. But what matters to lenders and borrowers alike is the manner in which housing booms end. In over 80 percent of the metro-area price booms we examined between 1978 and 1998, the boom ended in a period of stagnation that allowed household incomes to catch up with local home prices. While neither lenders nor current homeowners particularly like stagnation in home prices, such an outcome represents a necessary adjustment in market conditions that helps bring home prices within the reach of new homebuyers.
Mortgage lenders and borrowers encountered a great deal more distress in the 21 episodes of U.S. metro-area housing busts identified between 1978 and 1998. Fortunately, based on the criteria we use to define a housing bust, such an outcome can be characterized as relatively rare. In fact, only 17 percent of the housing booms identified during this period led to a subsequent bust, and where busts occurred they were typically preceded by significant distress in the local economy. To the extent that local factors continue to determine home price trends, the expectation would be that metro-area home price busts will continue to be relatively rare.
However, the broadening of the U.S. housing boom during 2004 may imply a growing role for national factors–including mortgage credit conditions–in explaining recent home price trends. More research is needed to establish exactly what role, if any, changes in the cost and availability of mortgage credit played in the expansion of the U.S. housing boom in 2004. But to the extent that credit conditions are driving home price trends, the implication would be that a reversal in mortgage market conditions–where interest rates rise and lenders tighten their standards–could contribute to an end of the housing boom. While our analysis shows that boom does not necessarily lead to bust, it remains to be seen to what degree the current situation might differ from our previous experience in U.S. housing markets."

Categories: real estate