The New York Times
By STEVE LOHR
THE housing market in California may look like a textbook case of superheated "irrational exuberance," but then how does one explain Spain?
Home prices there have risen 130 percent since 1997, twice the run-up in the United States.
These days, house price vertigo is more than a local or national condition. It's a worldwide phenomenon.
The American housing boom in recent years is nothing compared with the price run-up in countries like France, Spain, Britain, Ireland, Sweden and Australia, even though markets in Australia and Britain have cooled in the last year.
Million-dollar two-bedroom apartments are not only a fixture of New York, but of London, Paris and Hong Kong. In New Zealand, housing prices rose by more than 16 percent from 2003 to 2004. In Ireland, they rose more than 10 percent in that period.
The rise in prices is worrisome, because the international housing boom is a byproduct of globalization. A house on a plot of ground is the most local of assets. But the financial markets that make it possible for people to borrow money to buy a house, or speculate, are increasingly open, international and linked.
Interest rate policies in the industrialized world tend to move in lockstep, usually led by the United States. A growing community of affluent professionals around the world now buy second homes and invest in housing abroad.
The economic links act as a self-reinforcing network that has fueled the global surge in house prices but would also likely magnify the pain on the way down. The ripples would extend well beyond the housing markets. A fall in American house prices, for example, would crimp consumer spending - and free-spending Americans have supported growth in many export-minded nations, notably China.
"The real concern is that the housing boom extends across so many countries this time," said Susan M. Wachter, a professor of real estate at the Wharton School of the University of Pennsylvania. "That just raises the stakes, and the risk, when the music stops."
The global surge in house prices is a boom by design, largely manufactured by the world's central banks, led by the Federal Reserve. And it was done for good reason. Faced with a falling stock market and the collapse of the high-tech bubble, the Fed cut interest rates sharply in 2000 to try to limit the damage to the American economy and its trading partners.
Other central banks, like the European Central Bank, quickly followed the Fed's lead. Higher government spending and tax cuts were also part of the formula.
Cheap credit worldwide fueled the housing market, making mortgage payments less costly. Homeowners refinanced their mortgages at lower rates, and the savings went into consumer spending. They took out home-equity loans on houses of rising value, and spent that borrowed money on cars, clothes, furniture, restaurant meals and vacations. The higher consumer spending and the soaring value of the home nest-egg have kept the global economy chugging along.
"The Fed and other central banks encouraged this boom so that the wealth lost in the stock market was replaced by housing," said John Llewellyn, the global chief economist at Lehman Brothers in London. "And the housing boom has stimulated demand around the world."
The biggest globalization lift in house prices has been in what urban economists call "primate cities." These are the places where the world's well-off want to live or visit regularly for business or culture like London, Paris, New York, Boston, Shanghai, San Francisco, Miami, Sydney and Vancouver.
They are the most cosmopolitan of locales, often coastal cities and tourist hubs. They experienced the largest spikes in housing prices and pull up the national averages, while inland cities lag - the tourist coast of Spain outpaces Madrid, San Francisco outdoes Milwaukee.
Hitching the world economy to the housing market has worked well for policy makers so far. But it probably can't continue. House prices in general are continuing to rise both in the United States and abroad, as speculative buying and interest-only mortgages are proliferating.
"Much of Europe is like the United States, with roaring increases in housing prices," noted Michael Bell, a real estate economist at the University of Reading, in Britain. "The boom must be peaking soon. It just can't keep going up."
The looming, unanswered question for the global economy is whether the housing boom will cool down in an orderly way over the next few years or end in a bust. The preferred path would be for interest rates to rise steadily but moderately, slowing the pace of house price increases and forcing consumers to save more.
This is what the Federal Reserve and some other central banks, like the Bank of England and the Reserve Bank of Australia, have tried to do. The hope is that increased business investment would pick up the slack as housing markets worldwide calm down.
But the European Central Bank is contemplating lowering, not raising, interest rates. It is more concerned with slow economic growth, especially in large economies, like Germany's - where housing prices aren't skyrocketing - than smaller, hot economies like Spain's.
The peril is that conflicting policies could conspire against an orderly retreat. And any trouble would come at a time when policy makers, especially in the United States, have fewer options than in the past.
The huge American federal deficit, trade deficit and minuscule savings rate mean the United States borrows about $5 billion a day mostly from foreigners, whose purchases of mortgage-backed bonds have helped keep mortgage rates low.
If house prices drop and American consumers are forced to tighten their belts, buying fewer imports, China and other nations would have to slow their dollar investment spree, driving interest rates higher and higher. That could smack housing markets from Paris to Shanghai to Auckland.
C. Fred Bergsten, director of the Institute for International Economics in Washington, says the overheated global housing market is cause for concern. Yet the larger danger, he said, would be if it combined with another economic jolt, like an abrupt rise in oil prices, which would increase inflation and interest rates.
"That would burst the housing bubble, and be a very serious hit to the world economy," Mr. Bergsten said.
In a recently published paper, Thomas F. Helbling, an economist at the International Monetary Fund, studied 75 housing price cycles in 14 industrialized countries from 1970 to 2002. He found that not every boom is followed by a bust, but booms often are signs of possible trouble.
So applying Mr. Helbling's historical standard for booms to today's housing markets makes for nervous reading.
The housing markets in France, Spain and New Zealand have already boomed, according to Mr. Helbling's definition - that inflation-adjusted prices have increased 19 percent or more over the last two years. And prices in the Scandinavian countries, Italy, Ireland and the United States are nearing that level.
All these countries must be looking anxiously to Britain and Australia, where prices have peaked, and the question is whether they will experience a bust.
History and common sense, of course, teach that sooner or later, economic gravity will return to house prices, either gradually or swiftly, soft landing or meltdown.