Photo by Clif Droke

Real estate has once again come into the strong focus of the financial press. On front pages of newspapers this week we’ve seen the latest home start statistics showing another new high for April.

"New home sales hit a fresh record April -- new single-family unit sales up 0.2 percent"

The above was the headline earlier in the week as the Commerce Department said new single-family home sales rose to a seasonally adjusted annual rate of 1.316 million units, a new record, from a downwardly revised 1.313 million rate in March.

The word "housing" and "bubble" has been showing up with marked regularity in the news, with each new outbreak of fear and concern leading to higher highs, which can only be expected. It is almost as if the press has figured out that by injecting a healthy dose of fear in the headlines over real estate, they are helping to buoy the market as well as repairing the cracks that develop in the "wall of worry" as they develop from time to time. No matter, the presence of fear over a bubble will only prolong the real estate bull market as long as such talk persists.

Here are some other headlines that have shown up of late: "Regulation and fees add heat to a bubbling housing market," "Investors express concerns over sustainability of housing boom," "Worries over a housing ‘bubble’ persist."

More recently, on the front page of the Financial Times we find the following headline: "Big surge in price of US homes fuels fears of bubble." This is an extension of the "wall of worry" that will keep the real estate market buoyant in what otherwise might be a difficult market environment.

An article appearing this past week in the Financial Times headlined "Regulation and fees add heat to a bubbling housing market." The article explains the increase in local government taxes that builders face, which is forcing up prices according to the FT. According to the article, municipal government taxes have added $100,000 to the cost of a $550,000 home in at least one locale. Will these taxes succeed in cooling off demand for housing? Probably not, as taxes often do nothing to deter demand, especially when latent demand is already insatiable.

The article goes on to say that the federal Department of Housing and Urban Development, or HUD, believes excess regulation has boosted not just the cost of new homes and has had a spillover effect on the rest of the market. In response, HUD has launched a campaign to convince municipal governments to roll back some of the regulatory burdens, according to FT.

So how much help can home buyers expect from the federal government in controlling the housing bubble? Answer: not much. According to a report by CNBC on May 26, a U.S. government-designated online financial market called HedgeStreet.com "is offering home owners the opportunity to protect themselves against the uncertainties of the red-hot housing market."

According to CNBC, the web-based service lets speculators place bets on the expected future direction of home prices in six U.S. markets. "The idea," the article states, "is to hedge against a housing bubble bursting, which in many of the nation’s hottest housing markets would likely lead to a sudden drop in home prices." The article further states that HedgeStreet lets individual investors buy and sell small futures contracts known as "hedgelets," betting on whether median home prices in the designated housing markets will go up or down in three to six months time.

I thought I had seen it all when the CME introduced futures contracts on the weather. But this takes the home price mania to a new extreme. Anytime a new futures product is introduced it is always defended with the rationale that it provides an "insurance policy" against future volatility. But the reality is that these products only increase volatility and cause unnecessary financial losses for most of the participants. As Bert Dohmen of the Wellington Letter has said, "Stability reduces speculation, and uncertainty produces instability." It is uncertainty born of increased volatility that is breeding the urge to place bets on whether home prices will go up or down. This in turn increases volatility in a vicious cycle.

And since the U.S. government has apparently given its approval to this new venture, there is no hope that the current administration will do anything to keep the housing bubble from getting out of control.

If not the government, what about the Fed? Columnist John Murray of the Financial Times writes, "Sooner or later the Fed will have to call housing boom." He asserts that runaway real estate prices have "an even greater impact" on consumer spending and inflation. As Murray says, "Asset bubbles pose a huge challenge to any central bank that wants to control inflation." Will the Fed’s interest rate increases keep the housing bubble from getting even bigger...or will it create even greater problems? Unfortunately, history suggests that even the Fed’s efforts at controlling the housing boom are likely to fail; instead, they will only succeed in greater economic "dislocations."

In the end, the only cure for high prices is – high prices! Bubble booms must simply run their course and eventually fall victim to the cycles of time. The time for intervention has passed and it is too late to stop the bubble now without creating even bigger problems.

© 2005 Clif Droke
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Clif Droke
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Topsail Beach, N.C. 28445-9831 USA
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