The Boom Is—Is Not!—Over: The Great Real Estate Debate

Whether the eight-year boom was really a bubble remains a matter of debate among economists. No less a sage than Alan Greenspan started warning of "froth" in the market in May 2005--and the Fed has raised interest rates 17 times, at least partly to dampen speculative housing activity. Yet the party outlasted several years' worth of doomsday predictions. And for every bubble guy, there's one who thinks prices overall are about right, given mortgage rates that are still low by historic standards and other measures of affordability. "My view is that the run-up of home prices has been driven by the fundamentals," says Dick Peach, an economist with the Federal Reserve Bank of New York. He figures we'll have a soft landing.

Still, the slowdown seems certain to take a toll on the economy. Housing activity accounted for a full percentage point of last year's 3.5% GDP growth. Psychologically, rising home prices have made homeowners feel wealthier--just as stock prices did in the dotcom boom--boosting consumer confidence and spending on everything from cars to restaurant meals. Those rising prices, along with low borrowing costs, led homeowners to cash out a record $450 billion in home equity in 2005--money pumped into the economy. Rising interest rates have clogged that artery. And each month millions of homeowners have to write bigger checks to lenders as mortgages with adjustable rates move higher, another clamp on spending.

Perhaps most unsettling is that cracks are emerging in the Midwest, a region supposedly insulated from real estate madness. In Glen Ellyn, Ill., a suburb of Chicago, Deb and John Tritt have tried to unload their house for seven months. They've spruced up the place, knocked $58,000 off the price, to $739,000, and offered a week at their Hawaii time-share to an agent who delivers an offer. None of it has paid off, and two more houses in the neighborhood are for sale. "We're moving to a town home," says Deb, "and the only saving grace is that it's not finished yet."

Nonetheless, other buyers remain convinced that their nest is a good investment, not just a place to live. Mary Trujillo and her husband Jay just moved from a home in Houston to Naperville, Ill., where they bought a split-level ranch for $290,000. They're spending nearly twice as much on the new place and netted only $10,000 from the sale of their Houston home--after owning it for five years. "I think I have a better chance of making money off this house," says Mary. Call it the American dream.