And in the long run we are all dead.

Bubbles and the real price of housing discusses Robert Shiller's ideas. And it all seems to suggest that because there is long term stability, then rapid short term changes are somehow against the rules, suspect, a sign of decadence and, ironically, a "market imperfection." Yes, a great many right-wing bloggers seem to think that the vast number of American consumers who are bidding up house prices are wrong. At least that's what I tease out of both the substance and the politics of this issue. (i.e. There are 2 interesting questions around this issue -- What is really happening? How are people lining up on the issue?)

I am puzzled. The very chart which is used to demonstrate this point --

-- also shows a dramatic increase in housing prices in the early 1940s which did not lead to any sort of crash. Who is to say that our house prices will not also level off at some new and much higher equilibrium? Why need there be a collapse?

Comments

[chris brandow]

the magnitude of the increase certainly appears to be unprecedented. These are inflation adjusted numbers.

[Dr Blue]

For your theory to be correct (new level/equilibrium) you need to make the following assumptions:

1) American's have more real wealth than anytime in the past.
2) The increase in home prices is based on demand that is not due to liquidity.
3) Supply can not keep up with demand..
4) The marginal cost of building a home is the same prices as current houses are selling for.

Unfortunately, earnings and (real) wealth in America are not keeping up with prices (that is what the graph shows). What we have is cheap credit, fear, and uneducated speculators. The (coming) crash is really easy to understand. We are currently sitting on historically low interest rates. This initially made houses cheaper because monthly payments dropped significantly (while the boom has doubled prices payments have only gone up 10-15% on average over 5 years… about the same as inflation..) . Unfortunately people saw the rise in house sales price as a way to speculate and the boom was born. Prices climbed again and the boom was exacerbated by exotic financing schemes such as ARMS and negative amortization. People felt wealthy and starting taking-out loans against their homes and spending. This spending grew the economy. Builders saw the demand and started to build... and build and build (think Boston 1980s all over)... To add to this the government ran twin deficits and Asian financed cheap loans… Now Americans are looking at record debt as interest rates start to rise… fed is raising rates, China is revaluing, oil is near record highs, we are in an expensive war, the deficit is still growing, manufacturing has not rebounded nor has real job growth, health care cost are way up, all in all interest rates will need to rise in order to keep foreign investors interested in buying our debt (look up is-lm). Simply put we are looking at big debt, new bankruptcy laws, and higher rates… Consumes have little credit left to spend and the economy will now falter… On top of that builders and speculators have property that they will need to dump as the market stalls (look up bullwhip effect). Thus supply will increase and demand will drop… and prices will crash.. Sorry boss…. Now Wall Street is starting to wonder if mortgage backed loans are in trouble… that means ARMS and other financial tools are in trouble… or will be soon…

[David Sucher]

Well, I guess some people have no doubts.

The only problem is that the people who are widely considered experts on this very subject -- Professor Shiller, for example -- don't appear to be sure about _if_ much less _when_.

[Dr. Blue]

Other experts at major universities, who don't get the press of my good friend Dr. Shiller, are very sure. The date is not known but that is not really important. You need to stop thinking about the question (bubble or no bubble) and start looking at the data and what influences the data. What is on (driving) the supply side and what is on (driving) the demand side. You need to go beyond housing and look at macroeconomic conditions. What is liquidity? Ask why is credit cheap, how long will it be cheap, how much building has been going on, how much speculation, what are the effects in the long and short run, why hasn't non-housing jobs rebounded, what is going on around the globe that affect bond prices. If you ask the correct question you will see; the answer is - at best we will be looking at 7-10 yrs of no growth in the housing market (that is if rates don't go up... but there are futures markets for that so you can get a feeling for what the market thinks).

P.S.... Shiller knows.. he has publically stated that "this is the biggest bubble in history". I am sure prices will drop (soon) but I am not sure it is a bubble. A bubble means lots and lots of speculation. While the number of speculators is high I think the real down turn will be that people are over extended on credit, increases in building inventories, inflation, the cost of debt going way-way up. Supply might seem low now but it can change very fast (google "beer game"... click on the first link and play)

[lee]

I can't help but notice that huge trough. Yes the war ended it and the depression is in there but so are the roaring twenties and it started about 1915. Any thoughts?

[Dr. Blue]

Oh yea...the one thing that really could save all of the bad things that should happen when rates go up (assuming the federal reserve does not act) is that many corporations have actually used the low rates over the past few years to shore up their finances and build nice cash reserves. This could save us.. I doubt it will but it could (not sure why they would be willing to pay more in salaries with no real need to do so)..

[miss representation]

Were the data available a little further back, I would hazard this observation with a more confidence, but the spike you observe around 1940 looks more like a return to a historical mean, not an increase that is historically unprecendented. Whereas it might be possible that real estate as an asset class is undergoing a fundamental shift before our very eyes, both recent and deeper history would have that other similar claims (about, say, gold in the 70s and equities in general, or more specifically, technology stocks in the 90s) turned out to be a fool's proclamation. Arguments that investors will not respond to devaluations of this asset class the same way they do others (that is, they will ride it out and stay in their home, rather than move because of shrunken value) overlook two key indices that the bubble is being perpetuated by speculation: one, that first-time home ownership has not trended upward in a significant way (it has moved up, yes, but not dramatically), and the massive rise in very high-risk vehicles (interest-only mortgages were over third of new mortgages issued last year) that are underwriting the purchase (indicating that even if they are going to first-time buyers, those buyers are still speculators who can't carry the burden of such as asset purchase).

What's amazing about all this is we don't have to say, hey, don't you remember 1929, but rather, don't you remember 1999? That was only six years ago. Is everyone as delusional as the Bush administration?

[Dr. Blue]

Oh yea....On the new equilibrium idea. Because of a change in tax laws in the 90s and new financial vehicles I would guess that there is/was a new equilibrium above the historic level (maybe 135ish?? just a guess). However the market has over reacted (because after the last downturn there was not much else going on and free money made it easy ("it" being speculation and that exuberance thing). A correction is coming and if the index drops below 115 I would guess that means a lot of speculation is going on and builders have a lot of inventory. If you look at the stats on building permits you will see that there is a lot future homes that will be built. This will drive prices down even after the down turn. The myth of limited space is a trap. What you need to look at is the marginal cost of building. If the downturn is ugly enough and new lending practices (say fewer ARMS or risky loans..think Japan) are enacted you can guess that a new lower level will be seen (maybe 95???). So yea legislation and wealth will have an impact.

On the selling house issue. I sold mine 4 months ago about the time the noted real estate profesor at UCLA sold his. I only sold because of tax issues and longterm plans. If I had purchased the home 10 yrs ago I would not have sold. If I was sure that I wanted to stay in the house for another 5 I would not have sold. If the tax burden was too much I would not have sold. The market will eventually come back but if you want to move before then or have an ARM and are currently just managing the minimum payments you should really think about what will happen if your rates go up or if you become jobless. In case people have not noticed there are lots of good invesments out there that are more liquid than housing.

[David Sucher]

"In case people have not noticed there are lots of good invesments out there that are more liquid than housing."

Yes more liquid. But what sort of return? Risk? Can you work with it? Can you use it? I think a house is the sigle best investment for an individual.

There has to be balance and diversification but I think a house is an important element.

[Dr. Blue]

Wow well where to start. Yes housing is a good investment but a what price? Yes diversification is good but does that mean you hold over valued property (do you hold over valued stock even if it is overvalued?)? How would you define value??? and at what price? What makes something over valued and under valued? Was yahoo over priced at $200? Why??? What does present value of future growth mean to you? I will not answer these questions for you because I am sure that you are smart enough to look it all up.

Why is housing less risky? Something is only less risky when it does not vary to far from the mean.... Well according to that graph we are way off of the mean and we are into very risky. Real estate is also risk because you can't just sell it. It takes time and ooops you are trapped.

Diversification is good but you need look beyond the buzzwords. Purchasing overvalued assets no matter how diverse is bad.

Joe Kennedy dumped his stocks before the crash of the 1920-30s. He dumped because a shoeshine boy was trying to give him stock advice. He figured if shoeshine boys thinks they know something about the market then something is wrong and it is over valued. Two weeks later the market crashed.

In the late 1990’s many investors got out of the market after the New York Times ran an article about how a tax drive was getting a reputation as a hot stock picker… two months later the tech-sector crashed.

Now we have stories about porn starts going into real estate, teachers quitting their jobs to sell houses. We even have reality shows on how to flip houses…. Hmmm what doe this mean…

In the late 1980s the news was plastered with stories of Japan and how valuable real estate was. People jumped in bad loans were given out… now 15 years later… it looks like it might have hit bottom. Price regressed 30 years… but Japan has a lot more land then the US.

Diversify by purchasing land in Japan... today...

[Kevin Bryan]

1) Property bubbles are very common, and drops of 50%+ have happened in developed countries in recent years (Japan early 90s, for example)

2) As many others have mentioned, there's really no explanation for why prices have risen so much aside from speculation. Once interest rates rebound, and they will, there simply will be no way to *afford* these rates. A poster noted tax law changes, but that can't account for more than a slight increase (say 20-25%, if that).

3) Look at two data - the number of homes being bought as "second homes" (usually investment vehicles), which is something like 35% nationwide and much higher in the major bubble cities, and the rent:own split, which has seen house prices skyrocket while rents have been relatively slow to grow. Has there been a massive change in how people view houses/apartments from 1990 to today? I don't see it. These are clear signs of a bubble.

4) Greenspan is great, but his weakness has clearly been a tolerance of equity bubbles. A number of economic schools, the Austrians especially, would explain this bubble as being directly related to govt. monetary policy.

5) There are a number of policies that could be enacted which would "pop" the bubble sooner rather than later. Among them, we could shift from property tax to capital gains tax. So, instead of paying x% property tax, you would pay x% when you sell based on the difference between your purchase price and the selling price. This x% could vary, being higher for houses sold one year after purchase than for houses sold ten years after purchase (say 90% and 50% in the two cases). Improvements on the property would be deductible. This type of tax policy (just as one example) is a strong disincentive against speculative property purchases, and one I fully support.

6) In certain markets (Boston, SF/SJ, NY), young talent is leaving quickly because of the cost of living. In 20 years, today's high house prices are going to result in an impoverished economy, as places like Albuquerque, Phoenix, Austin and Tampa lure in new grads/PhDs with housing at half-price. Seattle would be smart not to allow this to happen in their city.

[Will Cox]

Lee asks above about the trough between approximately 1915 and 1945.

The simple explanation, just guessing from the dates, is that property values began to fall at World War I, and dropped precipitously when the Spanish Influenza decimated the population: a straight-forward case of too much supply and not enough demand. Prices adjusted upward but then trend down again until the creation of the Federal Housing Administration after the election of Franklin D. Roosevelt -- and promptly dropped as the U.S. entered World War II. After the war, we see what Miss Representation called "a return to a[n] historical mean." This corresponds with the post-war building boom. There's a trough at the Korean War, and a trend downward from Eisenhower to the end of the Vietnam War, but you'll notice that the curve is smoother in comparison to the pre-WWI curve. I can only suspect that the smooth curve is the result of secondary mortgage markets provided by Fannie Mae.

The critical question now is what the other side of that cliff on the right-hand-side looks like.

[Sam_S]

Great chart... Will pointed out some of the factors affecting prices. I was just going to say, don't get too excited about that ramp-up in the 40's as a precedent for today. It was at the end of a long, terrible depression, with the impetus of the G.I. Bill added. Pent-up demand combined with very easy financing for returning soldiers can explain a lot. Do we have anything like that today?