No Bubble Here-For Now

The bursting of the stock market bubble has led to a flood of deposits into credit unions, much of which has gone into underwriting mushrooming mortgage business.

But could the burst of a similar bubble in the mortgage markets come back to haunt credit unions?

Since April 2000, the Nasdaq bubble burst, the Internet Rush ended, dot-com companies laid off thousands and the U.S. economy suffered through a recession-yet housing prices have risen dramatically in many markets.

The combination of these factors recently prompted some observers to sound alarms of a second "bubble" that they say might burst and further damage the fledgling recovery, the so-called real estate bubble.

The good news, according to three experts who spoke with The Credit Union Journal, is a potential collapse of the housing market is neither imminent nor certain. However, they cautioned credit unions and other lenders to be wary of extending themselves too far as their mortgage portfolios bulge.

George Livermore, president of First American Real Estate Solutions and whose his company collects statistics on 93% of real estate transactions in the United States, observed, "We are not experts on credit risk policy for credit unions, but we can say there is no real estate bubble," said Livermore.

Dr. Christopher Cagan, First American's director of research and analytics and holder of a doctorate in mathematics, also suggested real estate "definitely is in a bull market, but not in any danger of a bubble bursting."

Housing costs are up 15% to 25% in many markets, but low interest rates have served as a counterweight, Cagan said.

"Because rates are down, mortgage payments are the same or less than in the 1980s, despite higher prices," he said. "Prices are above trends, certainly, but not so much above that there is a bubble." He added, "A bull market is not a bubble."

International economist Edward Leamer, who authors the U.S. portion of the quarterly UCLA Anderson Business Forecast, agreed.

"There is no symptom that would suggest the real estate market will be a bubble that bursts," Leamer said. "Mortgage rates are low and it is easy for people to qualify for loans."

Dr. Cagan said a bubble would exist if prices were far above historical values, or if people were buying houses "on spec" or taking out 120% loans in anticipation of properties appreciating.

Livermore said rather than simply looking at selling prices in an attempt to diagnose a problem, the nation's credit unions should instead watch the "affordability index"-the percentage of the population in a given area that can afford to buy a home. "If the affordability index gets too low then no one can buy, then there is downward price pressure," he explained.

California CUs Making More Mortgages

According to data supplied by the NCUA, CUs in California dramatically increased their percentage of mortgage loans compared to other types of loans between December 2000 and December 2001. At the end of 2000, 652 California credit unions reported nearly $44.7 billion in total loans. Of this amount, nearly $13.5 billion, or 30.1%, were loaned out as first mortgages (fixed rate and adjustable rate loans combined).

Just 12 months later, 626 CUs in the Golden State reported nearly $41.3 billion in loans, with nearly $22.4 billion of that in first mortgages-or 54.2%. That trend is also reflected nationally, with mortgages for the fist time comprising a majority of credit union loan portfolios and knocking off the traditional leader, auto loans.

Despite heavy layoffs in the technology companies in the Silicon Valley, housing prices in the San Francisco Bay Area remain stubbornly high. Leamer, a professor of economics and statistics at UCLA's Anderson School of Management, blamed this behavior on a "disconnect" between actual value and what someone else will pay.

Leamer termed this method "Survivor Investing," named for the popular television show. However, it could just as easily be described as "hot potato" home buying, as the last one holding the property could be the loser.

"The Bay Area is special. It benefited for several years from the Internet rush, but the only logic for buying a home there now at high prices is a firm belief in a tech bounceback," suggested Leamer. "People convince themselves that with low mortgage rates and this tech bounceback coming, they can afford the house they want."

"This is a speculative, risky investment, and is definitely is not diversified," Leamer added. "Their jobs and their house are dependent on the technology sector."

For two years, Leamer has urged the Federal Reserve Board to slow the pace of interest rate cuts.

According to Leamer, the earlier cuts were not given a chance to work.

"Low rates of interest have stolen future sales of both houses and cars. People are accelerating their commitments, which makes for a difficult period ahead," he said. "The economy will be fragile for the next two years because of this."

With so many people rushing to buy real estate and automobiles to take advantage of low rates, Leamer said he is concerned the markets for those two items might become saturated.

What It Would Take

"If the Fed is forced to raise interest rates to contain inflation, then the housing market will go into the tank, and you will get a bursting bubble," he assessed. "People are talking about a 'double dip,' or another recession, but that can only occur with a collapse in housing and cars. The two are historically linked."

First American's Cagan said lenders who become too generous after several years of good experiences are the ones that will get burned.

"If the market does start to turn in a couple of years, credit unions and other lenders could be exposed," he said. "It is up to the individual credit unions to check their lending policy."

Should the market turn, he added, some members may start looking for for unsecured loans.