INSIDE FINANCE
"Bubble, Bubble, Toil and Trouble"

By Robert M. Jaffe, MBA, AAMS
June 10, 2005

So began the incantations of the three witches over their magical brew in "Macbeth." And, dear reader, unless you've been hibernating recently, you and I know there's some witchcraft afoot in residential real estate that may indeed be a bubble soon to pop.

The most recent national median price for a home in the United States is $206,000, for the first time rising above the $200,000 mark. Here in Clifton housing values continue to precipitously rise as well throughout most of the nation. With national average mortgage rates at an ongoing low of less than 6%, 5.93% for a 30-year, conventional, fixed-rate according to Freddie Mac, housing demand continues to rise. (WSJ April 26). Just the other day I was told by a very savvy realtor acquaintance that the average price for a residence in Manhattan is now above $1 million. Yet, people seem to be willing to pay the price.

Speculation in certain regions such as Florida runs rampant. Stories abound of individuals purchasing homes as investments at pre-construction prices with the intent of selling them at a handsome profit when completed. The fire is further fueled by the reasonable ease with which one can obtain interest-only financing. Alan Greenspan, our guru at the Fed, stated recently "Without calling it a bubble, it's pretty clear that it's an unsustainable underlying pattern." (NY Times May 21) He referred to the situation as "froth" in the market with "a lot of local bubbles."

"The National Association of Realtors reported that sales of existing homes reached a record in April, an annual rate of 7.18 million sales, and the median price of a home had shot up 15.1 percent from one year earlier, the biggest jump since 1980." (WSJ May 31)

So how might this "bubble" affect you and me, happy in our present homes, with no intention of selling at this time? This is how I view it. Low interest rates have allowed higher and higher home prices, thus higher consumer spending and more debt. If housing construction slows, consumers (not you and I, of course) discontinue borrowing against their houses, and the economy slows. If the economy slows enough, and if houses begin to bring less on the market and consumers can't maintain their debt service, we could be headed for another dose of recession.

Where do we go from here? If lenders tighten their credit standards, that will help. Another means of slowing things without creating an economic turndown would be to have higher long-term interest rates. As of this writing, the yield on the 10-year Treasury note is 3.91% and the 3-month Treasury bill is 2.97%, and short-term rates continue to rise. Higher long-term rates should drive down the sales and prices of housing. In my estimation it's something of a "crap shoot." If you're in the market to buy, you're going to pay the piper. If you're in the market to sell you probably should do so, knowing that one of these days the value of your palace will become more realistic. In any case, just keep in mind the old song "Be it ever so humble, there's no place like home."

Please Email bob@cfsias.com with your questions.

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INSIDE FINANCE will appear regularly, addressing financial matters of interest to our readers. Any questions? Email bob@cfsias.com

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member NASD/SIPC. Cambridge and CFS are not affiliated.

The preceding article is for informational purposes only and should not be used as the primary basis for an investment decision. Indices mentioned are unmanaged and cannot be invested into directly. Past performance does not guarantee future results. All examples given are hypothetical and do not reflect actual investments. The views expressed in this article are those of the author and are not necessarily those of Cambridge. Bob Jaffe is Managing Director of CFS Investment Advisory Services, LLC in Totowa and has been a Clifton resident since 1984. Active in community affairs, Bob is Past Board Chairman of the North Jersey Regional Chamber of Commerce and a member of its foundation board. He serves as a commissioner on the Clifton Rent Leveling Board and the Committee for Individuals with Disabilities. He is Vice President of the Clifton Rotary Club. Representatives of Cambridge do not offer tax or legal advice. Consult a professional for your personal situation.