It is indeed a challenge to speak to you housing experts on the outlook for housing and mortgage lending over the next two year. All aspects of the housing ownership industry have been experiencing a record boom for the past few years, and you probably want to know how long this can last. I will do my best to provide some insights into that issue.

I want to acknowledge at the outset that many of my data and ideas come from work done by Mike Sklarz and Norman Miller. They have conducted a lot of detailed and high quality research about housing price trends in many specific markets.

Housing has been enjoying a wonderful boom over the past few years as a result of two conditions: very low interest rates, and the disaster in the stock market from 2000 to 2002.

Capital has fled from stocks into real estate, and particularly among consumers, into ownership housing. Since 1996, total starts, including manufactured homes, have been in the 1.8 to 1.9 million per year range, the best such period since 1983-1987.

In the past six years, annual starts of single-family homes have exceeded 1.2 million -- a level earlier surpassed in only three years: 1972, 1977, and 1978. And the constant decline in mortgage rates, plus high levels of home sales, have led to record levels of home financing and refinancing. You all ought to be fat and happy!

Annual sales of existing single-family homes have been sensational, almost doubling from 3.2 million in 1990 to 6.1 million in 2003. Total investment in new housing has risen even faster, doubling from 1994 to $373 billion in 2003. Last year, total investment in housing exceeded $500 billion for the first time ever.

Home prices have also been rising substantially, although at different rates around the nation. From 1990 to 2003, the biggest price rise in the NAR data for metropolitan areas was in Denver, with 185%. The median price for the entire U.S. rose 78% from 1990 to 2003, or 4.5% per year compounded. Home prices rose most in the Midwest, by 90.9%, but were still the cheapest there of any region. The highest prices were in the West with a $234,000 median, vs. $170,000 for the entire U.S.

It may surprise you to know that stock prices rose much more than home prices in the same period, but had a horrendous experience recently. On May 6, 2004, the Dow-Jones Industrial average was 260% above its level in January 1990, vs. only about a 78% gain for homes. But of course the Dow-Jones was still 14% below its highest value in 2000, whereas home prices were 22% above their level in 2000.

Moreover, home buyers were leveraging their gains with larger borrowings than most stock purchasers used. If the average home-buyer in 1990 put 20% down, that was $19,100. That home in theory has risen $74,500 in value, or 290% above the original down-payment -- more than the gain in the Dow-Jones average. Of course, part of that rise in prices was from a shift to larger homes, but I will ignore that. So home buying was a great investment in this period, which stimulated much more of it. The arithmetic may be a bit inaccurate, but the basic idea is quite sound.

Mortgage financing in this period has been even more booming than sales or prices. Total mortgages outstanding on 1-4 unit homes more than doubled from 1995 to 2003, rising by $3.8 trillion to $7.2 trillion. In the last three years, 64% of the originations were refinancings. So you were taking in the same washing over and over. In fact, 52% of the $ value of mortgages originated in 51 years from 1952-2003 were in the last eight years. And annual 1-4 unit mortgage originations rose 496% from 1995 to 2003.

There is little doubt but that this financing bonanza has helped sustain the entire U.S. economy during the recent stock-crash-and-terrorism-induced recession. Money taken out of housing fueled consumption and provoked housing price increases that led to even more home financing stimulus for the economy. Whether this will cause a housing price bubble I will discuss in a moment.

The key reason for this super boom has been low -- and falling -- interest rates. Since 1981 when the anti-inflation policy that produced super-high rates began, interest rates have been trending downward steadily. This has created a great climate for housing-related activities. But there is now a fear that this period is going to end, and rates will start climbing again.

One of the factors underlying falling rates has been the decline of inflation in this same period. The Consumer Price Index rose over 10% per year from 1979 to 1981, but then began a long steady decline to a 2.31% average in the past 7 years. This has been a major factor underlying the Federal Reserve's willingness to keep interest rates low.

One of the causes of this long decline in world inflation has been the entry of China's labor force into the modern world economy. There are 1.2 billion people in China; if half are in the labor force, that is 600 million. There are 4.8 billion other people in the world, of whom 800 million are in Africa, which is mostly out of the modern world economy. That leaves 4.0 billion excluding China and Africa, of whom, say, 2.0 billion are in the world labor force. When China's 600 million enter that labor force, that is about a 30% increase in the world's work force -- at low wages. This has kept world wages down and prevented manufacturing and other firms from being able to raise prices, as Walmart's success shows. That has been a major factor keeping inflation low.

Ironically, therefore, housing's recent -- and worldwide -- boom owes a lot to the impact of Chinese low-wage workers on the world economy. We have lost 2.7 million manufacturing jobs since 1994, many to China and other countries. But since 1994 we have also added 1.8 million jobs in construction and 1.1 million in finance plus 2.2 million in leisure and hospitality and 1.5 million in retail trade -- all partly related to relatively low interest rates and stable prices.

But what will happen in the future? Today China is growing so fast that it is absorbing so many commodities that world commodity prices have begun rising. Yet many Chinese and Indian workers have not yet joined the world economy. As they do, they will continue to exert a leveling impact upon world wages and therefore prices. On the other hand, as they consume more, they will raise demands for other goods like oil and food, thereby exerting a positive impact upon inflation. But net, I do not believe the world is in for as inflationary a period as it had right after World War II.

Even so, we cannot expect interest rates to be under the same net downward pressure that they have been since 1982. They are going to rise, not only as part of this business cycle, but also as part of a longer-run return to more "normal" conditions. This is a basic and less favorable change in the housing lending environment after a long period dominated by falling interest rates. This change is likely to endure for quite a while, not just a year or two.

Yet the immense impact of modernizing the rest of the world and putting its poor workers to work is going to keep anything like runaway inflation unlikely in the near future. That will partly offset the absence of declining interest rates.

Another rather disruptive force is the greater role of uncertainty in our economic future. After 9/11, we are subject to possible terrorist attacks that could upset our economy as that one did. And the Iraq war that sprang from terrorism as it has been interpreted by President Bush is another highly uncertain and risky factor in the economic outlook. An example of one such effect is the price of oil at over $41 per barrel. Another risk factor is our rapid movement toward the huge future federal deficits that neither political party is willing to confront. These factors temper what would otherwise be a rosy outlook towards at least two or three prosperous years.

In other words, although the general economic outlook is favorable, its certainty is quite tempered by unpredictable events that might upset another period of prosperity like that in the 1990s. Therefore, much caution should be mixed with basic economic optimism. This will keep overall stock prices from rising as much as they otherwise might. Right now, stock prices are 2 to 3 percent below what they were at the start of 2004. And wobbly stock prices will keep making real estate investments look relatively sound.

Now let me discuss whether housing markets are going to experience a "bubble" followed by a crash like that which occurred in the stock markets in 2000 through 2002.

Markets for housing -- especially owner-occupied homes -- are quite different from other types of real property markets because nearly all the properties are already occupied by households who mostly have to keep on living somewhere. Therefore, unlike office, retail, hotel, or industrial properties, there cannot be a massive withdrawal from demand or consumption to undermine the cash flows that are supporting home properties.

True, in rental properties, demand does shrink in recessions because renters can go back home or double up with friends, and they do. But in owner-occupied housing, most households still have to keep living somewhere, so they might as well stay in the homes they are already occupying, even if prices of those homes fall sharply. That is why demand cannot suddenly vanish, as it does in other real property areas.

Moreover, most households will continue to have some income, even in a severe recession; so they can keep up their basic mortgage and utility payments. If they were planning on selling their homes when prices fall or stop rising, they will just defer that action and wait until prices come back again -- even if it takes years.

True, if you are a builder who has sold a lot of units to speculators who plan to flip them without occupying them, you are at risk of a shrinkage in demand. But most builders do not sell many units to speculators -- and if you do, you ought to stop!

These observations mean that housing prices will not continue to rise as rapidly as they have in the past few years. There are some "natural" checks on home prices that limit such increases. One is that people have to pay the cost of occupying their homes. That means their incomes and wealth limit their ability to support high prices.

I admit that the levels which home prices have reached in the San Francisco Bay Area defy all rational analysis, even of incomes and amenities and wealth. But it is still true that home prices cannot keep rising forever faster than incomes and wealth

The first homes to experience declines in prices are those in the highest levels and the best neighborhoods -- just as they are the first to rise in price at the beginning of a home price cycle. The wealthy people who can afford such homes are the most sensitive and best informed about current trends. At the moment, in many areas these highest-price homes have already fallen in value by as much as 20-30%. Mike Sklarz and Normal Miller have analyzed such high-priced homes in many regions and found them to be suffering from such price falls already.

Generally, the prices of other homes in less wealthy areas or even less fashionable communities will start reflecting the same trends as these highest-priced homes but not until after some months -- even lagging behind as much as 1 to 2 years. For example, Sklarz and Miller found that Los Angeles home prices lead those in Bakersfield by as much as four or five quarters. They think that Los Angeles and San Diego and Orange County are price leaders in Southern California -- with non-coastal areas and even Santa Barbara lagging behind quite considerably. Similar relationships undoubtedly exist in other regions of the nation.

I believe the sustained run-up of housing prices will definitely slow down or stop once interest rates begin to rise, or even before that in anticipation of higher rates. As noted, this has already begun to happen in the highest-priced and most fashionable neighborhoods, and it will spread to other parts of the housing market.

However, there are other reasons why housing prices will not "burst like a bubble" and then go into a tailspin similar to that of NASDAQ stock, which fell over 70 percent in three years. You cannot sell housing short, as you can with stock. There are no margin calls to force owners to sell when they don't want to, as there are with stocks, though some foreclosures have this quality. There are lender and appraiser constraints on the run-up of prices, though they have not been terribly limiting in the hottest markets. And it takes much longer to discover what the true price of your home is when you want to sell it than it does with stocks, because homes are much more illiquid and unpublicized.

But the most important factor is the one I started with -- most homeowners occupy their homes themselves. So if they cannot get the prices they want, they just stay there and hold out until market conditions improve. True, about 10% of owners move each year, but fewer have to move. And that also means 90% do not move. The result is that when demand for housing falls sharply, prices start to move down but most potential sellers hold out by holding on. So prices move mostly sideways during the depressed-demand period until conditions improve. Bubbles don't explode, they sort of fizzle sideways until the world catches up with them.

Although housing prices will not burst like a bubble, the volume of mortgage lending is much more likely to do so by dropping precipitously. The demand for housing space cannot collapse suddenly, but the demand for mortgage lending can -- especially because such a high fraction of it has been refinancing existing mortgages. From 1993 to 1994, the dollar volume of refinancing originations fell 60% when interest rates rose by 120 basis points, year to year. From 1998 to 1999, the dollar volume of refinancing fell by 43% when mortgage rates rose by 60 basis points. In both cases, total 1-4 unit originations also fell by around 20%. I believe you are in for another similar experience in the next 1 to 2 years.

Thus, the problem you will face is not so much falling prices as a decline in the demand for new and existing homes and especially in the demand for refinancing existing homes. When homeowners cannot sell at the prices they want, they sit there and the inventory does not turn over as fast. But sales of existing homes have fueled much of the big boom in both new home building and sales of existing units. And refinancing of existing mortgages has been a huge part of total originations.

Existing home sales soared from 3.8 million in 1995 to 6.1 million in 2003 -- a rise of 60.5 percent in just 8 years, when population was growing only 9.0 percent. If interest rates rise sharply, sales could fall off as they did from 1978 to 1982, when they declined by 50% as rates soared.

The Mortgage Bankers Association is predicting that both housing starts and sales of existing units will decline in 2005 below 2004, and refinancing will drop from 66% of dollar originations in 2003 to 25% of originations in 2005. As a result, MBA predicts total originations will fall by 54% from 2003 to 2005 as interest rates rise by 110 basis points. I am not going to make such detailed forecasts, but I believe the basic idea that the mortgage lending business is in for an immense contraction in the next 2 years is right.

This is not just a temporary change, but a basic shift in market conditions from falling interest rates -- which have prevailed since 1982 -- to flat or rising rates. That is likely to lead to a long-run shrinkage in the amount of mortgage lending on one-family homes, especially refinancing. Your business is bound to shrink a lot. You may not like to hear this, but I believe in telling you the truth as I see it.

This will occur even though I do not believe interest rates will rise nearly as sharply as they have in the midst of severe inflation. The Fed will be reluctant to raise rates much until after the Presidential election. Then it will raise them gradually unless there is a big run against the U.S. dollar, which would force a rapid rate run-up.

The housing market is likely to cool off substantially in the next year, unless the stock market goes into another nosedive. I do not believe that will happen, though no one can forecast stock prices reliably. Home prices should stop rising and may decline further at the high ends of the market, especially where they have run up very greatly.

The highest-priced metropolitan areas are all over: 6 in California, 8 on the East Coast, 2 in the Midwest, 3 others in the East, and 4 others in the West. But all with median prices over $300,000 are on coasts of California, Hawaii, or the NE.

As a result, the mortgage lending business should slow down immensely, especially if rates go up enough to choke off your huge refinancing business. When rates at first rise, there is a rush to refinance before they get much higher, but I do not think that will maintain the rate of lending that has been going on recently.

In conclusion, your business is going to slow down significantly in the near future, especially after the presidential election, but perhaps considerably before then as well. This will inflict a lot of pain on your industry because you have expanded to cope with recent high levels of volume. Much consolidation and reduction in size is in your future.

On the other hand, the news is not all bad. You are not going to experience a massive loss of economic value in the huge amount of loan collateral you have financed, though default rates should rise somewhat along with interest rates. Home prices will slow down and even stop rising across the board, but they will not collapse, though some at the high end will decline a lot.

After all, you have just enjoyed a once-in-a-lifetime boom in most aspects of housing -- and especially in the mortgage lending industry -- except the occupancy levels in rental housing. Those have declined partly because people keep on building and buying apartments. So it is time for a rest.

And you can rest assured that Americans still have huge faith in the value of their homes, not only as places to live, but also as pillars of their financial security. After what they have seen the stock market do, a slight sideways movement of housing prices will not disabuse them of the view that personal real estate is still a great way to invest for one's future and for one's present consumption as well. So don't switch to being a stock broker just because your housing-related business slows down.

In the long run, both housing and mortgage lending will remain viable and profitable businesses, but mortgage lending may be at notably lower levels as long as interest rates stay flat or keep rising. But in the short run, you are in for a sharp contraction in the mortgage lending business that will put you to the test. I am telling you this to prevent you from experiencing what will happen as an unpleasant surprise, like that in the story with which I will conclude.

Remember, it's the long run that counts. So hang in there. As Terry Bradshaw said, each day thank God you are still alive, and smile at lot at everyone! Good luck.

As Robert Strauss once said to the President of the United States at a Gridiron dinner, "You can fool some people all of the time - and those are the ones on which you should concentrate your efforts." On that happy note, I will conclude.