What goes up must come down. Unfortunately, the old adage applies to just about everything, including real estate, even California real estate. For more than a decade, home prices in the state have been on the rise. Some economists, noting the rapid escalation in home prices since the tech bubble imploded in 2000, have voiced concern that a new bubble has formed in the real-estate sector. The recent declines in home prices throughout the nation and the state, including Sacramento, have caused some to wonder if the real-estate bubble has finally popped.
If it has burst, the results could be disastrous. Although the economy has picked up some steam during the past year, the recovery has been weak; the red-hot housing market has been one of the few sectors propping it up. If it goes, some experts argue, so goes the economy.
By any measure, the climb in home prices has been precipitous. According to 2004 U.S. Census data, the median home price in Sacramento County has nearly doubled since 2000, from $144,200 to $287,262. That’s an increase of almost 100 percent. On the other hand, median household income has remained relatively flat, rising from $43,816 to $49,632, a gain of 13 percent.
That means the ratio between home price and income—the figure bankers use to help determine eligibility for home loans—has also nearly doubled. In 2000, the median-priced home was 3.3 times the median income. In 2004, it was 5.8 times the median income. Other regions in California have ratios as high as 10-to-1. Three decades ago, bankers considered 3-to-1 a prudent ratio between home loans and income.
Such conservatism has gone out the window as financiers, backed by the federal government, have granted increasingly risky loans. Nowhere has this been more prevalent than with the burgeoning use of adjustable-rate mortgages, so-called ARMs.
These financial devices provide homeowners with a below-market interest rate during the first few years of the loan. Then, as interest rates rise, so do ARMs. The device has become enormously popular, particularly among real-estate speculators. From 2002 to 2003, the number of Sacramentans choosing ARMs increased from 21 percent to 46.9 percent, according to DataQuick, a firm that monitors real-estate activity nationwide. That’s fine, as long as interest rates remain low.
But lo and behold, for the first time in a decade, interest rates are on the rise, thanks in part to a federal deficit that has ballooned to $8 trillion because of President Bush’s misguided tax cuts and the debacle in Iraq. Increasing interest rates is the only way to entice foreign lenders to continue financing our debt.
The need to increase interest rates, combined with rising energy prices, is creating what some economists are calling a perfect storm. If interest rates aren’t increased, foreigners will stop lending us money, destroying the economy. If rates are increased, the housing bubble could collapse, destroying the economy. There’s no getting around it; the nation is looking at some difficult decisions ahead.