By Bill Sing
Times Staff Writer

7:57 PM PDT, September 27, 2005

California’s housing boom appears to be peaking, and the resultant slowdown is expected to produce “weak growth” in the state’s economy during the next two years and a possible recession by the end of 2007.

That’s the view of economists at UCLA Anderson Forecast, which plans to release its widely watched quarterly outlook this morning.

“There are some signs that the housing party is ending,” said Christopher Thornberg, senior economist at the University of California, Los Angeles group and author of its California forecast.

Thornberg points to an almost doubling of homes on the market in the past six months, a flattening of sales activity and the widening use of high-risk mortgages that buyers are using to acquire today’s pricey homes. Property in California, he said, is now overvalued between 40 percent and 45 percent.

“The forecast for California is mediocre at best, at worst we are liable to dip into another recession,” Thornberg said, putting the odds of a recession by the end of 2007 “at least 50 percent if not more.”

The latest UCLA outlook is slightly more downbeat than its previous report in June “because I think we’re at the peak” of housing, Thornberg said. UCLA economists have long warned that a decline was coming and could end badly, but this is their strongest suggestion yet that the top may finally be at hand.

Although UCLA forecasters have consistently been more pessimistic about the housing boom and California economy than many other analysts, their views are notable because they were among the first economists to predict the 2001 recession and to identify the current housing boom as a bubble.

UCLA economists have said signs of housing speculation were emerging as early as 2002 — and since then the median California home price has risen 71 percent, from $266,000 to $456,000.

Because the state’s job growth and consumer spending have been supported by rising home prices, any flattening of real estate values would cut into overall hiring and prompt consumers to rein in their pocketbooks, the UCLA forecast said. Job creation in other sectors is not strong enough to fully offset declines in housing-related fields such as construction, the state’s fastest-growing job sector, the report said.

“When consumers realize they can no longer expect that appreciation bonus to subsidize their consumption habits, they will very likely pull back on spending,” Thornberg said.

Other analysts agree that the state’s dependence on housing has added risks to its economy. Although he didn’t specifically cite California, Federal Reserve Chairman Alan Greenspan on Monday again warned of potential price declines in housing.

But other analysts don’t necessarily agree that the real estate boom is over yet, or that job growth will cool anytime soon.

Keitaro Matsuda, senior economist at Union Bank of California in San Francisco, said the California housing market “still has a lot of momentum” thanks to strong demand supported by rising job growth and consumer incomes. Employment growth in the service sector is gaining strength, he said, and could help offset any slowdown in real estate-related employment.

Even Hurricane Katrina might help the state’s housing market, said Steve Cochrane, regional economist at Economy.com in West Chester, Pa. By slowing the national economy, the storm could keep mortgage rates low, he said.

“That could give the housing market in California another year of life before it slows down,” Cochrane said. He noted that the state’s housing market started to slow last fall, then got a second wind this year.

UCLA’s Thornberg agreed that a peaking housing market doesn’t necessarily mean prices will plunge. Prices could continue to rise, but at a much slower rate. That’s already started to happen in previously hot markets such as San Diego and the Bay Area, he said.

Typically, it takes 12 to 18 months before a slowdown in housing dampens the overall economy, he said.

Published Thursday, September 1, 2005

Hurricane season notwithstanding, it’s hard to watch the news without seeing some report on the housing market. And while real-estate investment never really achieved broad collegiate appeal — unlike keg stands, for instance, or iPods — this housing situation is nonetheless symptomatic of, and contributing to, a debt crisis in America. Therefore, to facilitate discussion on this important issue, I present my brief, high-altitude summary of debt in America, and the three great delusions of the housing fiasco.

First, a little context: On the tail of the dot-com crash, the Fed lowered interest rates, hoping to avert recession with a soft landing. The goal of this rate drop was to spur borrowing, quell saving and inject money into the economy through consumer spending. The 9/11 attacks marked another impetus for economic slowdown, countered immediately with further rate cuts and those bizarre presidential edicts commanding citizens to travel to Disneyland and spend money. This, in short, began a sustained, multi-year period of rock-bottom interest rates, which of course translated to cheaper borrowing costs, low mortgage rates and, among other things, more people eagerly shopping for homes.

A deluge of hungry buyers leads to market unbalance, and is met with increased production where feasible, and increased prices where not. This is exactly what occurred in some coastal markets of California, Florida and the Northeast, with home prices soaring alongside a boom in new development wherever space would permit. In the hottest markets — like Los Angeles, San Diego and Miami — house prices have posted double-digit annual appreciation for several years, with many properties doubling or trebling in value since 2002.

The exact definition of a speculative bubble is the subject of some debate, but, for our purposes, let’s say it constitutes any situation where people feel compelled to invest with urgency in a product whose intrinsic value is less important than the promise of profit. Thus, the nature of the product and the price paid are functionally irrelevant, as long as some buyer exists who is willing to pay even more. This “greater fool” theory powered the recent dot-com boom, just as it once fuelled the Dutch tulip craze.

This brings us to Delusion One: that real estate always rises in value. Any cursory study of history will show this belief is simply untrue; nonetheless, polls show that a disturbing number of people believes real estate values always go up. A significant share of homes is now sold to speculators (or “flippers”), whose only intent is to re-sell the property for profit.

That real estate can only increase in value is a dangerous assumption, one that bears primary responsibility for Delusion Two: that negative-amortization, interest-only mortgages are a good idea. If home prices in your area have outstripped the amount you can afford, you might weigh what Alan Greenspan politely termed an “exotic mortgage”: a debt where, despite hefty monthly payments, you are left after five years owing more on your house than its initial sale price. Without getting mired in detail, such mortgages defer all principal and some interest payments for a set period, usually two to five years, end-loading the unpaid interest onto the principal. In my view, such products are useful in only two instances: first, when a buyer’s income will increase sufficiently to cover the major jump in payments after the five-year introductory period; and second, if the property value will rise sufficiently during those five years to cover the increased principal with a sale. If either of these assumptions proves untrue, the owner is in trouble. Unheard-of as recently as 2001, in some areas such mortgages are now used in upwards of three-quarters of all home purchases.

And here we introduce the important — if obvious — notion that in order to profit from real-estate appreciation, you must actually sell your property. The problem with this is that, unless you rent or move to a different city — or the property in question is a second house — any comparable house you can buy is just as pricey as the one you’re selling. This unfortunate complication has been termed the “golden prison” phenomenon: Homeowners watch helplessly as their houses appreciate, unable to cash in without spending even more to move.

American indebtedness has reached epidemic proportions. Greenspan deferred a deserved recession with a sustained infusion of cheap money, allowing us to deny reality for a few years. But amid this furor of consumption, warning signs abound: The personal savings rate dropped to zero in June. Foreclosures and bankruptcies are up, the latter at record highs. Check-cashing joints are among the fastest growing businesses in the nation — a glaring beacon of a society living above its means. The housing bubble looks poised to burst: Rents remain low, often falling far short of covering the mortgage costs on rapidly appreciating properties, and in many markets housing may already have peaked — evidenced by a drought of buyers amid a glut of stale listings.

Across the country, millions cling to the belief that housing gains are real, hoping their prime store of wealth won’t suddenly evaporate in a market correction. And who knows? Maybe they’re right. Maybe interest rates will stay at record lows, home prices will continue to appreciate, and an insatiable pack of well-heeled suckers will buy anything that needs to sell. Too many homeowners are staking everything on the best possible scenario, praying that a rainy day will never come. We all hope for the best — but don’t bet the house on it.