Courting a Real Estate Bubble

There are several indicators of a potential real estate bubble. How should credit unions react?


A bubble is a temporary market condition that is caused by excessive buying, often propelled by easy credit that contributes to an unsustainable run-up in prices. Some signs of a bubble may include:

  • New belief that purchase will be rewarded with quick and/or low-risk returns
  • Future price increases are forecast on the basis of past price increases
  • The fad is a primary topic of conversation/discourse
  • New valuation approaches are substituted for traditional means of estimated value
  • It doesn’t feel right or logical

There has been a lot of discussion recently about the supposed real estate bubble and what it means for the U.S. economy and consumers. In fact, the market share across all major search engines for the Internet search “real estate bubble” is up 311 percent from a week ago, according to Hitwise, an online tracking service.

The 22 major metropolitan markets in which house prices are growing the most rapidly serve as a good barometer of real estate appreciation. In 1995 these markets accounted for 24% of the value of the nation’s residential real estate. In 2000, they grew to 27%. Now, they have risen to 35% of the value, but represent just a fifth of the population, according to the FDIC.

Below is a graph that plots annual population growth in the top 20 metropolitan areas that have the highest rates of house price appreciation against their annual population growth using the most recent data available.

The correlation between these variables is weak, as R squared is only 0.0025. If the data points were more correlated, it would signify that these cities’ house prices were related to a higher population growth rate. However, the above graph provides more evidence that there is a real estate bubble, as opposed to purely demand-driven price gains, as metropolitan areas with similar population growth rates experienced differing house appreciation rates.

Why It Matters to Credit Unions

While several scholars are downplaying the real estate bubble theory, there are a few areas of concern:

  • “Risky” mortgages- Many members are turning toward interest-only and various adjustable rate mortgages to afford more expensive homes and still have low monthly payments. Adjustable rate mortgages have risen from 36% to 41% of all first mortgages for credit unions in the 12 months ending March 31, 2005.
  • Speculation- Speculation is a growing concern and may be the first avenue that the real estate market takes to correct itself. According to the National Association of Realtors, speculative purchases rose to 23% in 2004 from 16% in 2003.
  • Real Estate versus Equity Market- Houses are not as liquid as the equity market and have higher transaction costs involved, which may deter comparisons with the stock market bubble of the late ‘90s. Houses are also a commodity that consumers use in addition to purchase, which should provide a floor to house prices that stocks do not have.

Take Action

To alleviate balance sheet risk, credit unions have a variety of options. First, they can sell their first mortgages to the secondary market. Credit unions have sold $3.7 billion worth of first mortgages to the secondary market year-to-date.

Credit unions can also reexamine their mortgage lending policy to determine whether the loans they are placing on the books are reasonable in today’s real estate market. With the increased popularity of non-traditional mortgages, it may be a good time to evaluate what loan-to-value ratios and loan guidelines are appropriate in today’s context.




July 4, 2005


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