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Wednesday, June 23, 2004 - Page updated at 12:00 A.M.
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Hot housing prices not likely to cool, study finds

By Mashaun D. Simon
Bloomberg News

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U.S. home prices are not likely to plunge, and the housing market is not in the middle of a national "bubble," according to a study released yesterday by the Federal Reserve Bank of New York.

The report by senior economist Jonathan McCarthy and Vice President Richard Peach sought to determine whether an increase in home prices results from speculation or is supported by the value of the assets.

Home prices have increased about 36 percent since 1995, double the rate of other booms in the past three decades, the study said.

"Our analysis of the U.S. housing market in recent years finds little evidence to support the existence of a national home-price bubble," the authors said. "Rather, it appears that home prices have risen in line with increases in personal income and declines in nominal interest rates."

For their study, the authors used a definition of a bubble developed by Joseph Stiglitz, a Nobel Prize-winning economist at Columbia University. That definition says a bubble exists "if the reason the price is high today is only because investors believe that the selling price will be high tomorrow — when 'fundamental' factors do not seem to justify such a price."

There are few signs that the market is strong mainly because investors expect rapid price appreciation, the report said.

Official figures show average home prices rose 7.7 percent in the first quarter of 2004 from a year earlier, but that masks sharp regional differences. In Southern California, prices are up 26.9 percent from a year ago.

The study said that even if prices soften in California and the Northeast, experience suggests that would not be enough to push the economy into recession.

The recent increase in prices has been in line with declining mortgage rates, a factor ignored by many arguments about a housing bubble, the study said.

The study has important implications for Federal Reserve interest-rate policy. Evidence of housing bubbles in both Britain and Australia has influenced their central banks to raise interest rates in the past year to cool the market.

Peach said if housing prices level off or decline, there would be offsetting factors to take into account that would limit the negative impact on household spending.
"If home prices were to fall, that would, all else being equal, have a dampening effect on consumer spending.

"But of course, the thing that's most likely to drive up (market) interest rates is faster economic growth, rising employment and faster income growth, which are a plus for consumer spending," Peach said.

Information from Reuters is included in this report.

Copyright © 2004 The Seattle Times Company

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