by Nicolas P. Retsinas
Septeber 24, 2006
The Providence Sunday Journal

"HOUSING BUST AHEAD." The headline hints of catastrophe: a dot-com repeat, a bubble bursting, an economic apocalypse. Cassandra, though, can stop wailing: the expected price corrections mark a slowing in the rate of increase -- not a precipitous decline. This will not spark a chain reaction that will devastate home owners, builders, and communities. Contradicting another gloomy seer, Chicken Little, the sky is not falling.

Let me alleviate some fears.

Fear One: Prices will plummet.

From the start, the much-vaunted housing "boom" was an uneven phenomenon, driven by a strong demand for housing, coupled with constrained supply, particularly on the two coasts. In much of the nation, housing prices rose modestly; in a few areas, prices did not budge.

In those overheated markets -- often fueled by immigration -- prices were rising by as much as 20 percent a year. But even with soaring demand and limited supply, that escalation was not sustainable. Even with too-good-to-be-true mortgages, people cannot afford to buy homes that cost five times their income.

So in those overheated markets, moderation is expected. Moderation means that prices will stop rising at meteoric rates: The home owner who expected a double-digit profit after one year will be disappointed. A home will once again be more of a domicile, rather than an investment. In some regions, prices will flatten, rising around the inflation rate, which is the historic average. The fundamentals behind high prices -- strong demand (more households will form in the next decade than in the last) and constrained supply -- persist.

Fear Two: The economy will collapse.

Housing now represents over 20 percent of the gross domestic product (compared with 18 percent from the manufacturing sector). For most families, the investment in a home constitutes de facto savings: the build-up of equity is in the trillions of dollars. And home owners have tapped into that equity, using their homes as ATM machines for refinancing and home-equity loans.

Consequently, we are "well housed." Indeed, two bathrooms, air conditioning, garages -- the amenities our grandparents called luxuries -- are standard.

All this activity has fueled consumer spending.

A Cassandra fear is that as home prices moderate, the moderation will show up in the gross domestic product. Yet, again, moderation is not a free-fall. The housing market will adjust slowly, with fewer sales and starts. History tells us that housing booms are not eternal -- that most end -- enabling incomes to catch up with prices.

Furthermore, builders have been building to meet demand. In regions where the number of households is growing, so is the need for housing. That demand will not slake. So the incentives for developers remain strong. We will see more construction over the next decade than over the last -- and the last decade set a record.

Of course, Cassandra has not been the only one watching housing prices fall. Some Pollyannas have cheered the fall, predicting that at last housing will become more affordable: The $200,000 home will go for $150,000; the $150,000 home (in some parts of the country, this is a rare ramshackle) will go for $100,000. Renters desperate to buy into the American dream yet lacking the down payment -- much less the income to finance a mega-mortgage -- will get their raised ranch. And as more middle-income renters buy homes, the shortage of rental housing will ease; rents will drop; and the "affordability" crisis will fade.

Pollyanna, though, is shortsighted. Yes, some would-be owners, previously shut out of the market, may at last buy a home. But the "affordability" crisis will persist -- exacerbated by rising interest rates.

The working poor face their own income-and-expenditure imbalance: Their incomes fall short of their need for housing, food, transportation, and health insurance. They will still be hard-pressed to pay for a basic apartment close to their jobs. If the market "self-corrects" in the fast-growing parts of the country, that self-correction will not trickle down far enough to help the Wal-Mart clerk or diner waitress.

In our new economy, low-wage jobs are growing. These people will still need public intervention.

Cassandra can stop wailing, and Pollyanna can stop cheering. Home prices in some regions are moderating, but for a nation inured to CNN's headline-of-the-moment, this moderation does not rate high on the Richter scale of cataclysm.

Nicolas P. Retsinas is director of the Joint Center for Housing Studies, at Harvard University.