by Calculated Risk on 4/20/2005 05:36:00 PM

The Economist asks: Will the walls come falling down?

A few excerpts:

The increasing riskiness of mortgages is not the only sign that America is experiencing a housing bubble. The ratio of house prices to rents is well above its historical average, as is the ratio of prices to median incomes. And people seem increasingly to be basing their house-buying decisions on the notion that the large capital returns of the past few years—house prices in America are up by 65% since 1997—will continue indefinitely. As with a stockmarket bubble, if this confidence is shaken, prices could begin to fall rapidly.

More likely prices will deflate slowly over a multi-year period. Housing: After the Boom on Angry Bear looked at the impact on prices and volume transactions in previous busts. Prices deflated slowly, but transactions dropped precipitously.

A fall in American house prices could be bad news not just for American homeowners, but for the rest of the world. Robust American demand has supported export-driven growth in many economies, particularly emerging markets and Asia. If American consumers have to raise their abysmal savings rate, exporting nations will feel the pinch.

And finally this:

Most worryingly, a collapse in American export demand could trigger a vicious cycle. In order to keep their currencies low against the dollar, and thus boost exports to America, Asian central banks have been accumulating dollar reserves, which they have poured into Treasury bonds. This has increased the supply of capital in America, and thus been at least partly responsible for the borrowing binge that fuelled the housing boom. If house prices fall, and suddenly poorer Americans have to cut back on their purchases, this will shrink the supply of cheap credit from Asian central banks, pushing up interest rates and causing house prices to fall even further. Those who thought that housing was a haven may be in for a nasty surprise.

Emphasis added.
For a diagram on how this might work, see Housing and Trade: Virtuous Cycle about to Become Vicious? Check out The Economist article and the interesting chart on the global nature of the housing boom.