By Martin Wolk
updated 7/15/2005 3:38:59 PM ET 2005-07-15T19:38:59

In his first major policy address as President Bush’s chief economic adviser, former Fed Gov. Ben Bernanke devoted a few moments to discussing the current housing boom sweeping the nation.

Major Market Indices

He cautioned that “speculative behavior appears to be surfacing in some local markets,” and said lenders and banking regulators need to remain “vigilant.” But he also said sharply rising home prices are being supported by fundamental economic factors including “low mortgage rates, rising employment and incomes, a growing population, and limited supply of homes or land in some areas.”

“For example, states exhibiting higher rates of job growth also tend to have experienced greater appreciation in house prices,” he said.

Can it really be that simple? Can rising home prices be explained as a natural outcome of a growing job market?

To check on Bernanke’s assertion, I looked at state-by-state data on employment and home prices and discovered that yes, many of the states that have seen the strongest home price gains over the past year have also seen some of the best job growth, including Nevada, Florida, Arizona and Virginia. But job growth and other economic fundamentals can only go so far in explaining the surge in housing prices, especially when you take a longer-term view.

For one thing, home sales and prices have been rising steadily for five years, breaking records year after year, even throughout the recession of 2001 and the jobless recovery that followed. If home price gains now are explained by rising employment, how do we explain the gains of 2001 to 2003, when the economy lost more than 2 million jobs and the unemployment rate was rising?

Secondly, the latest price gains in the boom states seem entirely out of proportion to the relatively modest job growth figures.

Take a look at California. Over the 12 months ending March 31, California ranked No. 2 in home price growth, behind only Nevada, with a statewide average gain of more than 25 percent, according to a quarterly price index published by federal regulators.

But California added only 250,000 jobs last year — about in line with the 1.7 percent job growth rate seen in the nation as a whole. Even more interesting: From 1999 to 2004, California’s work force only grew by 2.9 percent while home prices rose 103 percent. Compare that to the boom years of 1995-2000, when the work force expanded by 17 percent yet home prices rose only 47 percent.

The same disconnect can be seen over and over again. In New Jersey, New York and Connecticut, home prices rose an average of 13 to 16 percent over the 12 months ending March 31, a bit better than the national average of 12.5 percent, a near-record rate. Yet job growth in all three states was well below average last year — New York state added only 80,000 jobs, or 1  percent of its work force.

To stick with New York, in the mid-‘90s the state’s work force added 800,000 jobs over five years, and average home prices rose 30 percent. From 1999 to 2004 the work force shrank by 50,000 jobs, yet home prices rose 71 percent.

Even in Nevada, which has led the nation in growth over the past decade, the pace of job growth has slowed over the past few years compared to the late 1990s. Yet home prices, which were rising a bit faster than inflation until a few years ago, suddenly zoomed through the roof beginning in 2003.

Of course job growth alone can hardly be expected to explain home prices, which are influenced by all the factors mentioned by Bernanke — income growth, demographics, constraints on new construction and, perhaps most importantly, interest rates. Long-term mortgage rates generally ranged from 7 to 8 percent in the late 1990s, compared with 6 percent over the past several years.

Still, the price gains seen in places like California, Florida, New York and the Washington, D.C., seem to reflect a psychological element that goes beyond such fundamental factors.

“You get the sense that housing is increasingly becoming the stock market of this decade,” said Mark Zandi, chief economist of “People talk about housing the way they did about stocks five years ago.”

Zandi is among a growing number of analysts who say risky new loan products that appeal to speculators, like negative-amortization loans, are at least partly responsible for driving up prices in the hottest housing markets.

“I think it’s an increasingly worrisome development,” he said. “The impact is too small to date to be a macroeconomic issue, but given these trends, in another year I don’t know whether I could say that. Regulators should become more aggressive in trying to stem this kind of mortgage lending.”

Doug Duncan, chief economist for the Mortgage Bankers Association, a trade group, said anecdotal evidence suggests lenders are being careful in underwriting these new loans although there is not enough history yet to determine how they will perform over the long term.

He sees little risk of widespread price decline, although he believes there are “tiny bubbles” forming in some markets with multiple risk factors, including home prices that have risen sharply for years, drawing in a significant number of speculators.

But Duncan said home prices are being supported strongly by demographic factors including the enormous wealth of the baby boom generation, whose members are in their prime years for owning first and second homes.

Patrick Lawler, chief economist for the Office of Federal Enterprise and Oversight, a mortgage industry regulator, said the motives of many of these home buyers are hard to discern, possibly even in their own minds. Baby boomers who might be interested in owning a second home might be more likely to act now that housing seems to be such a lucrative investment option.

But he said the sharp price gains seen in many markets along both coasts have got to taper off eventually.

“The rates of increase are not sustainable,” he said. “The question is are we going to see flat growth over a period of time, or will we actually see some declines?”

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