Limits on building permits = higher home prices

In June, the term "housing bubble" was used 312 times in American magazines and newspapers. That's up sixfold from a year earlier.

If chatter alone pricked a price bubble, we'd hear a bang, or at least hissing.

But so far, no pop, no hiss. As of the second quarter of this year, home values in the United States were up 14.1 percent in the past year, reports David Berson, chief economist for Fannie Mae, a major buyer of home mortgages from financial firms.

His "best guess" is that home sales are "very close to peaking." In some hot housing markets, such as San Diego and Washington, homes are taking longer to sell. But prices aren't tumbling.

How come?

Blame today's high house prices, often staggering to first-time homebuyers, on the Federal Reserve's past "excessively easy" monetary policy, says veteran Wall Street economist Robert Parks. Low interest rates and the Bush administration's expansionary fiscal policy have created "an unprecedentedly big and dangerous bubble," warns Mr. Parks, who predicted the last two stock-market crashes. "All big bubbles burst. However, nobody can say just when."

Harvard University economist Edward Glaeser reserves judgment.

"It could happen," he says. "But I don't know."

His relative calm stems from research with two other economists indicating that the main reason house prices have flown aloft in the past 20 or 30 years, particularly on the two coasts, is the increasing difficulty in getting regulatory approval to build new homes.

That situation won't change anytime soon. Last week, the Census Bureau reported the July annual rate of housing starts as barely exceeding 2 million. That sounds like a lot, but the rate of growth in overall housing has fallen. In a sample of 120 metropolitan areas, the housing stock expanded 40 percent in the 1950s. In the 1990s, it rose only 14 percent. Further, housing growth in that decade was just about 7 percent in San Francisco, New York, and Los Angeles, notes Mr. Glaeser.

Cities have changed from "urban growth machines to homeowners' cooperatives," he notes. Developers probably are less able to "bribe" or otherwise get city officials to grant them zoning changes or permits for unpopular new housing. More affluent, more educated residents use their political clout to block such developments, which could damage their own house values or the beauty and convenience of their district.

In what Princeton University economist Paul Krugman has called the "flatland" (the Midwest), it is easier for builders to turn farms into housing than in the "zoned zone" (heavily zoned areas on the coasts), where it is generally hard to obtain land to build on. So home prices are far lower in flatland.

Nonetheless, the "man-made scarcity" of new and old housing has been spreading, Glaeser finds. That said, what else can homebuyers do but bid home prices up?

"Bubbles in housing would have a lot of trouble existing if it weren't for limits on residential construction," Glaeser adds.

Other factors have contributed to rising house prices. More than 1 million immigrants, legal and illegal, enter the US annually and need housing. Albert Saiz, an economist at the Wharton School in Philadelphia, figures each 1 percent increase in immigrants relative to a city's population boosts rent and housing values by about 1 percent.

But that element is not nearly big enough to explain the real increase (inflation removed) in the average house price in 316 metropolitan areas from $80,556 in 1970 to $138,601 in 2000.

Nor do construction costs explain the price surge. Since 1970, the cost of building a house has declined slightly on a nationwide basis. Builders have learned to keep costs down, especially in major developments with manufactured houses. That's so even in bubbly markets. Real construction costs between 1970 and 2000 rose a mere 4.6 percent in San Francisco, 6.6 percent in Boston. Yet at the same time, house prices rose 270 percent and 127 percent, respectively, in those metro areas.

Merrill Lynch economist David Rosenberg wonders how long home values can "defy gravity" - that is, how long the vast gap between rising home values and stagnation in family incomes can last. Real hourly wages for workers were $16.15 in November, 2001, when the current economic recovery began, and $16.13 last month.

"The ratio of starter-home prices to first-buyer income has surged to 5.5 times, from 5 times a year ago," writes Mr. Rosenberg. "Based on the past ..., at a minimum we are likely to see a sharp slowing in home price momentum and very likely a drop in real terms."

Parks suspects that rising mortgage rates or an economic slump could kick off a decline in home prices. "Once fear gets into the [money] markets, interest rates could surge markedly overnight - or while you are at lunch," he says.

So scary talk could have an effect on interest rates, and thus on home prices.