Washington, DC, June 9--Federal Reserve policy makers' jitters that surging home values could be an asset bubble ready to burst may be unfounded, a recent study published by the Cleveland Fed says.
The national median existing home price rose 15.1 percent in April from the same month a year ago, the National Association of Realtors reported in May. It was the biggest 12-month gain since November 1980, the real estate group said.
Some analysts point to strong demand for homes, rising incomes, low mortgage interest rates, and lack of room for new construction in coastal cities to explain the run-up in house prices.
But other observers note with alarm the leap in the ratio of U.S. house prices to rents by nearly 30 percent in the last five years to argue that home value gains are unsustainable, Joseph Haubrich and Ben Craig write in an article entitled "Too Much Risk?"
Among those worried are Federal Reserve officials including Chairman Alan Greenspan.
"Without calling the overall national issue a bubble, it's pretty clear that it's an unsustainable underlying pattern," Greenspan said last month.
However, a closer look at the data suggests the increase in the price-to-rent ratio is exaggerated, Haubrich and Craig say.
The authors looked at possible signs of asset bubbles because members of the Fed's policymaking Federal Open Market Committee fretted in December that a prolonged period of low interest rates might be leading investors to take excessive risks, including speculation in housing markets.
Analysts often cite data published by the Office of Federal Housing Enterprise Oversight to demonstrate the price-to-rent ratio jump, Haubrich and Craig said. But OFHEO data -- which looks at repeat sales -- ignores renovations, add-ons, and other improvements to property, Haubrich and Craig said.
When looking at a Census Bureau house price index that looks at new home sales, the authors found that the price-to-rent ratio had increased 7 percent since March 2001 instead of the 19 percent gain registered when using OFHEO data.
"This apples-to-apples comparison suggests that much of the increase in home prices comes from higher quality, not speculative excess," the authors wrote. Haubrich is a consultant and economist and Craig is an economic advisor at the Cleveland Fed.
Meanwhile, in another paper recently published by the Cleveland Fed, economic advisor Paul Gomme said policy makers should step in to prick asset bubbles, particularly in stock markets, before they become large enough to cause a broad setback to the economy.
While links between stock markets and the broader economy are loose, stock crashes can cause recession, Gomme said in a paper called "Why Policymakers Might Care About Stock Market Bubbles."
"Policy makers may wish to step in to end the bubble before stock prices get too far out of line relative to fundamentals," he wrote.
