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Will Katrina burst the housing bubble?

As the scope of the damage from hurricane Katrina becomes clearer, Answer Desk readers are wondering about the wider economic impact. Bryan in New Haven is wondering whether the disaster's aftermath will be the final straw that bursts the housing bubble?
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As the scope of the damage from hurricane Katrina becomes clearer, Answer Desk readers are wondering about the wider economic impact. Bryan in New Haven is wondering whether the disaster's aftermath will be the final straw that bursts the housing bubble?

What effect will Katrina have on the housing market "bubble" across the country? With so many destroyed homes in the Gulf area people now have no nest-egg to sell, which also leaves nothing for others to buy. I suppose those with good homeowners insurance could use the money to rebuild or purchase an existing home somewhere else. But how likely are people to rebuild versus renting for the rest of their lives? It seems like the old rules of housing Supply and Demand have been turned upside down. What are your thoughts on where this is leading?

          Bryan L., New Haven, CT

Katrina’s impact was so vast it’s hard to see how it won’t end up having a huge impact on many facets of the economy, including the housing market. But we suspect in the storm will also end up taking the blame for a lot of things it had nothing to do with — everything missed corporate profits to the flop of a new product. It’s just too easy an excuse to pass up.

So it’s hard to unwind Katrina’s impact on housing from all the other economic winds that were blowing well before the storm made landfall; there are a lot of pieces to this puzzle. There’s some evidence, for example, that buyers in overheated housing markets were already beginning to recover their sanity before the disaster struck.

And for the record, we’re not a big believer that housing bubbles “burst” suddenly – except perhaps for speculators who’ve overextended themselves. (Including all you Answer Desk readers who keep asking about how to “flip” real estate. Fair warning) When times get tough, people tend to stay put, which brings far less selling pressure than you get with, say, a stock market panic.

One way to answer the question is to look at the two major forces that have helped fuel the housing bubble in the first place: low mortgage rates and rising expendable income. If rates rise and home buyers' budgets get pinched, hot housing markets could cool quickly.

Let’s look first at interest rates, which are closely tied to inflation. Farmers are bringing in the fall harvest just as the shipping along the lower Mississippi River struggles to return to normal — a barge bottleneck could force food prices higher. Gasoline prices, already up sharply pre-Katrina, got a big boost from the lost refining capacity knocked out by the storm. The massive rebuilding that’s expected to begin soon will put a severe strain on supplies of building materials, potentially raising those prices. With the insurance industry and the federal government flooding the region with tens — maybe hundreds — of billions of dollars at once, it’s easy to make the case that there’s a risk of higher inflation. 

So far, consumer prices overall seem to be under control, though consumer inflation has picked up — largely due to higher energy prices. That could get worse when soaring winter heating bills hit home. And when it does flare up, inflation usually brings with it higher long-term interest rates — as investors demand higher payback to protect their money from the corrosive impact of inflation. A sizeable jump in rates could easily throw cold water on the housing market. (Again, so far, there’s no sign that’s happening.)

Now let’s look at incomes. It’s clear that unemployment will be widespread in the region as hundreds of thousands of displaced workers find themselves out of a job. It’s far from clear how many businesses will return — or how long it will take them to get back in business.

Some people in Katrina’s path may collect insurance payments, unemployment insurance or other storm-related government assistance. But that still leaves them with less of the long-term buying power needed to buy a home. Consumer budgets also could be further strained by higher prices (see above). And worries about all this could further hurt consumer’s confidence in the economy, which may prompt people to postpone house-hunting until Katrina’s impact becomes clearer.

In the end, bubble’s burst for a variety of reasons — even though, after the fact, one factor or event may get singled out for the full blame. The Internet bubble, for example, burst because investors finally came to their senses — for a variety of reasons. We’d suggest that the era of runaway housing prices will likely end for roughly the same reason.

I'm having real problems with the concept that we are not undergoing an inflationary period. I know what the government says the CPI is, but I've been tracking my family expenses to the penny for two full years as of August 31 — our last significant change of life. In the last two years we have had no significant changes in our purchasing habits, but the cost of food, housing, medical care, transportation and utilities have increased 35.4 percent over that period. That's pretty much everything but entertainment and clothing, both of which we've had to cut back on drastically, and does include a shift from fresh produce to frozen. And it isn't just gasoline either — every single category I mentioned is up at least 20 percent. I've talked to other people like me and they all say the same thing — the cost of living is going up double digit. Yet the CPI says there's no inflation. Where's the disconnect?
William D.,Reno, Nevada

Wow -- talk about having your spending under control! Congratulations on a job well done. (Um, could you help me balance my checkbook?)

Our best guess is that the disconnect is between the average behavior and spending patterns of all American (which is what government statistics like the Consumer Price Index represent) and the experiences of real people like you and me.

Most household budgets include the categories you describe: We all need to put food on the table, a roof over our heads, clothes for ourselves and families, and maybe a trip to the doctor or a night at the movies. But it’s highly unlikely that your budget mirrors the average in each of the many categories the government uses to track the spending used to calculate the widely-cited CPI inflation index.

Transportation, for example, makes up nearly 20 percent of the “average” U.S.  household budget in the broadest measure used by the Bureau of Labor Statistics, the keeper of the CPI. So if you drive 30 miles to work in a pickup that gets 12 miles to the gallon, your “transportation inflation index” is going to go up a lost faster than, say, a city dweller who takes the bus to work and doesn’t bear the expense of owning and operating a car.

According to the currently-used breakdown, the “average” American spends 40 percent of their budget on housing, 17 percent on food, roughly 5 percent each on medical, recreation and education expenses. In my case, with tuition bills for two kids, I’m spending way more than 5 percent of my disposable income on education. So my “education inflation index” is rising much faster than the retired couple whose kids have graduated. And if those retirees are covered by Medicare, their out-of-pocket medical expenses may be lower than yours and mine as well. Since the inflation rate for higher education – like medical care – is rising much more quickly than the overall “average” inflation rate, my household inflation rate will be higher than someone who doesn’t have tuition bills to pay or has better medical insurance.

The folks at the BLS get pretty specific: it turns out, for example, that of the 1.124 percent of all household spending went to pay for fruits and vegetables, .098 percent went to pay for apples and .086 percent was spent on for bananas. Coffee makes up .101 percent of the “average” household budget. And .270 percent was spent on bedroom furniture.

So while you may prefer bananas on your cereal and an extra cup of coffee with breakfast in your new bed, if I grab a cup of tea and eat an apple on the way to work, our personal inflation rates will be different.