Alex Tabarrok looks at the image below and asks the question that dare not speak its name: was there even a housing bubble?
Alex says:
The clear implication of the chart is that normal prices are around an index value of 110, the value that reigned for nearly fifty years (circa 1950-1997). So if the massive run-up in house prices since 1997 was a bubble and if the bubble has now been popped we should see a massive drop in prices.
But what has actually happened? House prices have certainly stopped increasing and they have dropped but they have not dropped to anywhere near the historic average (see chart in the extension). Since the peak in the second quarter of 2006 prices have dropped by about 5% at the national level (third quarter 2007). Prices have fallen more in the hottest markets but the run-up was much larger in those markets as well.
Prices will probably drop some more but personally I don't expect to ever again see index values around 110. Do you? If we don't see the massive drop back to "normal" levels then the run up in prices should be described as a shift to a new equilibrium - much as happened during World War II - see the chart. (It's an important question to ask what changed and why?). In the shift to the new equilibrium there was some mild overshooting, especially due to the subprime over expansion, but fundamentally there was no housing bubble.
What bothers me is that I don't understand why we should have shifted to a new equilibrium. I think I understand the reasons that the equilibrium values shifted between 1940 and 1950:
- Developments in rail and construction techniques in the 1910-20 brought huge amounts of land under development, and pushed urban buildings rapidly upward, at a time when population growth was slowing, depressing prices
- The Great Depression kept them low
- This massive pent up demand translated into a boom in housing demands as incomes recovered
- The FHA, and then the Veterans administration, basically introduced an entirely new product: the long term amortizing mortgage. Previously, mortgages had been short-term affairs with balloon payments at the end; five years was a very standard term. The long-term amortizing mortgage, especially when helped along with government subsidies, massively increased the amount a couple could pay for their house.
- Housing demand was then sustained by high rates of real economic growth and population growth, which caused housing demand to skyrocket.
- Prices leveled off as the automobile brought new land into housing, but since the mortgages kept demand pegged to incomes, they never actually fell
- The post-1970 fluctuations are money illusion, responses to changes in nominal interest rates.
I find it hard to name a comparable equilibrium changing development in 1997. I am fairly well convinced Ed Glaeser's argument that high coastal real estate prices are due at least in part to the fact that local interests are increasingly effective at blocking new development. But that's been going on for decades; it didn't suddenly change in 1997. One could argue that this was when credit scoring models started getting much better, making more credit available, and indeed homeownership rates soared--but they soared from 64% to 69%. (By contrast, between 1940 and 1950, they went from 43% to 55%.) Also, it turns out that credit scoring wasn't that much better, as proven by rising default rates.
Alex's theory is supported by the fact that housing is bubbling up all over--the US, in fact, experienced rather modest appreciation. I'm tenatively willing to believe that this represents a real expansion of credit availability--but I still wouldn't buy a house right now without a hefty downpayment to cushion the downside risk.
"I still wouldn't buy a house right now without a hefty downpayment to cushion the downside risk."
You should delete the words "right now".
But when you have a high down payment you bear the risk, when you don't the bank does.
If you can get an atractive rate with a low down payment why not? That seems to be more of an, issue for the bank. If house prices fall it does not affect your ability to make the payments so if you are happy in your home you don't have to move, but if they fall and you do want to move you can just mail the keys to the bank selling the house is their problem. Sure your credit will suck but if you rent for a few years someone will lend to you again.
IMO that is one of the main problems in this mortgage mess, the banks sold a bunch of people a put option but did not price it as a put. But that is not really a problem for the homeowner it is a problem for the bank.
Now probably you can't get a good rate anymore unless you put down 10-20%. But that is a different question..
Not sure I understand the argument. Just because it is very unlikeley that prices won't go back to 1997 levels (or that there are modest increases in prices in some areas now), doesn't mean that there was no bubble.
But if you are looking for a factor that shifted values, besides the usual (and likeley) suspects of cheaper, easier to get loans, how about this:
The plethora of home improvement shows, from This Old House to all those shows on HG TV and so forth that glamorize buying a home and fixing it up. After all, what was the companion boom to the housing bubble? It was the home improvement boom. I know you couldn't find a contractor in the SF Bay Area to, say, rehad a kitchen to save your life during those years. And see how this has crashed harder than the housing bubble in the last year or so. See, for example, the collapse of Home Depot's stock price the last two years.
Note that Schiller's table is for existing homes only, and not new homes. The home improvement craze could explain a lot of the uptick.
Prices will return to the long-term trend. Tabarrok is simply wrong. The collapse in prices will be a long run thing, however- it won't happen in a year or 5 years time.
Don't know how it affects land/housing, but the emergence of the internet into common culter is closely associated with this rise.
Why would a shift in equilibrium require a sudden change in anything? It could just be that around 1997 we passed some threshold related to factors such as the affordability and size/quality of housing that started pushing prices to the new equilibrium.
A couple possibilities come to mind for me. First, has there been a large increase in the cost of producing a house, pre-1997 to post-1997? If so, that could reflect itself in higher housing prices.
Second, is there something like the "peak oil" scenarios going on here? It's possible that all (or most) of the "easy" housing locations have been taken up and built on. That would tend to raise prices for all houses.
It could just be that around 1997 we passed some threshold related to factors such as the affordability and size/quality of housing that started pushing prices to the new equilibrium.
Consider how houses keep getting larger and larger (even as families get smaller). The "starter house" is a nearly obsolete concept.
Mixner wrote: It could just be that around 1997 we passed some threshold related to factors such as the affordability and size/quality of housing that started pushing prices to the new equilibrium.
For example, maybe somewhere around 1997 we entered a period of unusually strong economic growth with historically unprecedented lows in unemployment, which enabled more people than ever before to enter the housing market...and then had a housing bubble follow on top of it.
size/quality of housing
That and credit availability are the most likely culprits. I'd be very interested in the normalized price per square foot. I would expect it to compress all post-WWII peaks.
What about the change in the capital gains tax rate. Essentially you can take up to $500K in profits every two years tax free per couple. This is a huge reduction in the marginal tax rate, and coupled with a huge reduction in the cost of capital, the rapid rise in house prices makes a lot more sense.
Coward may be onto something. Tax rules for sale of a principal residence changed dramatically under the Taxpayers Relief Act of 1997. The old rules were a $125,000 one-time exclusion after age 55. Now (somewhat simplified) it's $250K/$500K single/married as many times as you want after 2 years of residence.
What if it's not so much credit availability as much as dramatically increased credit creativity. If most people think of their mortgages in terms of monthly payments, and banks develop products that allow one to buy much more home for the same monthly payment, wouldn't prices become much more elastic? Prospective buyers, focusing on monthly payments after all, will presumably be both much less likely to make an offer below the list price and much less likely to walk when their initial offer isn't accepted. The market clears at a higher price, and because most buyers don't feel the effects of that higher price where it would immediately hurt--in the monthly payment--there's little incentive for anyone to check the upward spike in prices.
What's wrong with this view?
I'd like to see the Shiller Home Price Index based on urban/suburban/exurb. I live in the exurban area south of Denver and had the misfortune to buy high. I've had to move for work and after 6 months on the market rented my house. I'm paying a lot to keep a renter since the rent doesn't cover the mortgage. I put quite a bit down but with realtor fees & closing costs I'm not sure I wouldn't have to pay to walk away. I was back there recently and saw lots of vacant homes as I got away from the city. I think there was a massive overbuilding of the large lot, large house exurbs. The latest issue has an article about these as the new tenements. I certainly hope I'm not part of a trend. I pay my bills and put a lot in my 401k but I'm contemplating walking away from my house.
"Now probably you can't get a good rate anymore unless you put down 10-20%. But that is a different question."
Until very recent years, you never could before because lenders had this peculiar idea they should assure the risk of loss would be borne by the buyer rather than the lender. That is because centuries of experience shows lenders who fail to take that simple precaution tend to go out of business when jolly conditions fade.
What's happening now is simply a step "back to the future."
Anonymouse has a partial answer to the search for a comparable equilibrium changing development in 1997: around 1997 we entered a period of unusually strong economic growth with historically unprecedented lows in unemployment
I'd add: we also had a period of inflation stability which wasn't messed up by a Democrat president. Once the markets saw that both parties could be trusted to control inflation and not create interest rate shocks, inflationary expectations fell significantly, reducing the margin lenders would require for mortgage lending.
The obvious explanation for the 1997 takeoff, as opposed to 1996 or 1998, though, is the change allowing people to shelter $250,000 of house value gain from taxes, every two years. This suddenly made more money available for buying houses.
"but I still wouldn't buy a house right now without a hefty downpayment to cushion the downside risk."
future market prices care not about the size of your down-payment..
also, credit availibility is the driver--it has to be, it's all there is, credit, in our current Economy..
Another factor contributing to higher housing prices post-WWII. Previously a significant fraction of the existing housing stock lacked plumbing, elctricity and central heating. But the number of such houses declined drastically in the 40s and 50s. Houses were quite literally more valuable because they provided more amenities. But I don't see anything like happening in the late 90s. Sure houses got a bit bigger, but that's hardly a revolution on the scale of flush toilets, showers, lighting, heating a cooling.
Does Tabarrok have any actual argument to make as to why prices will not fall to 110 again? It would require prices to flatline for a few decades. Why is this impossible? Why is it "unlikely"?
Are demographics at play here? I remember reading somewhere that a large component of the cost of rearing children is housing - getting into 'good' school districts, which drives up the cost of housing in those districts. Where was the spike in the population of school-age offspring of the baby boom generation? (I don't know, but seems plausible that it was in that decade at least.)
He's right. It isn't a bubble, that's a myth. Only morons think it's a bubble. Everyone with a working brain knows that it was just an unprecedented rapid rise in price, followed by a steep, ongoing decline. Just like the chart shows.
I remember reading somewhere that a large component of the cost of rearing children is housing - getting into 'good' school districts, which drives up the cost of housing in those districts.
And of course we know what 'good' really means.
It is artificial. If you look at markets like Orange county or San Diego you will see a 2500 sqft home at a 1/3 acre lot is priced as same as 2500 sqft home at a 1/10 acre lot. You would think may be its the building cost. Hmm the same house at Arizona cost 50% less. I do not believe its the price difference. Its the interest groups control over issue. There is no shortage of land [otherwise homes with more land would cost more].. They just would not allow you to build so that the price will be up and they can make hefty profit and make us pay more.
As credit card debt and massive college loans have become the norm for all age groups, and as real wages have stagnated, it has become conventional wisdom in America that, to live decently or to keep up with your neighbors, you either have to inherit wealth or live with levels of debt that until recently most people would have avoided like syphilis.
Nevermind the fact that economic realities have not changed at all - these levels of debt ARE crushing us. But low-dollar policy and supply-side theory have encouraged excess spending, as has our irresponsible tax policy. From the federal government to the individual household, people have started believing that you don't have to make as much as you spend, even for decades at a time. When American jobs are less secure than at any time since the Great Depression, that is a very dangerous thing.
This institutionalized lunacy delays the reckoning somewhat, but it doesn't make the underlying falacy any more true. And what we are decidely NOT delaying is our relative decline in long-term viability versus other nations, especially China.
The wealthy few who have sold a remarkable number of simpletons this point since 1986 do not give a damn about any of the above or the fact that American society is also rapidly stratifying as a result - they are fine at the narrowing top, and Most of them will be dead by the time America is too weak to secure its citizens' liberties.
I agree that the change int he standard mortgage was a significant factor. Under the old mortgage system home ownership had been quite stable at around 40% from 1900 to 1940.
If we are going to have a permanent shift in the income/house price ratio I suspect we will have to develop a new type of standard mortgage.
TK,
Half of all U.S. households have no credit card debt, and the median debt of the other half is only around $2,000. Yes, total debt is high by historical standards, but that's because assets are high too. People have more assets to secure loans. Household net worth is at or close to its all-time high despite the decline in real estate values over the past year or so. Also, wages are a poor indicator of living standards, and to the extent that "wages have stagnated" is true, it doesn't tell you much about the standard of living, which also depends on all sorts of other factors such as non-wage income, non-wage employment benefits, and the effects of taxes and transfers.
"but I still wouldn't buy a house right now without a hefty downpayment to cushion the downside risk."-MM
future market prices care not about the size of your down-payment..-MEH
True. If you really want to protect yourself, sneak that hefty downpayment into the Caymen islands a little bit at a time, then buy the house on a big mortgage. Then, if the worst happens, you lose the house, but not the downpayment.
From 1997 to 2000, there was a huge business cycle boom that affected the housing market. From 2000 to 2003, real interest rates fell dramatically. That's why there would be a new equilibrium. Do you find Bernanke's international savings glut story implausible as explanation for the housing boom? (And if so why?)
You might ask why we didn't have such a huge boom in the late 1970s, when real interest rates were even lower. But we did have a boom, and we know that nominal house prices are slow to adjust. Basically, house prices didn't have time to catch up with the interest rate fundamentals before those fundamentals shifted (and we went from incredibly low real interest rates to incredibly high real interest rates).
Another issue is the required risk premium associated with housing. Obviously that premium dropped significantly from, say, 2000 to 2006, and it has subsequently risen significantly. To the extent that there was a bubble in credit, house buyers were arguably pricing rationally given the terms that were available to them.
Megan's right about the down payment reducing downside risk. All else equal, a bigger down payment means a smaller mortgage and a smaller chance that the selling price (after expenses) won't cover the remainder of the mortgage.
You could achieve the same thing by leaving a good chunk of money in a liquid account, but the point is that in either case you initially need to save up a good chunk of money.
Then, if the worst happens, you lose the house, but not the downpayment.
Second-worst, technically. "Worst" would be where the Feds figure out what is going on, and you promptly lose the house, have your assets frozen, and spent five to ten in the white-collar pen.
The average house size in the United States increased from 1,700 square feet in 1978 to 2,456 square feet in 2006, according to the National Association of Homebuilders. from the OC Register real estate blog.
Size of houses has had a meaningful effect on the average price paid, with the effect amplified by teardowns of smaller houses to build larger ones.
I don't have any answers, but I have two questions.
What has the change in the size of homes been during these time periods?
What change has occurred to the rate of secondary home ownership?
This doesn't really take into account that in the 80's mortgages carried almost 20% interest, and during the boom, they got as low as 5%. That makes a big difference in what people feel they can afford when buying a mortgage.
A comparable trend line analysis was reported for the UK in the Financial Times a while back. The analyst, who looked at the last 100 years of housing prices and the trend line, suggested that UK house prices would have to fall 40% to get back to the trend line, which seems to be consistent with what is reported here. But that level of deflation would have major consequences for the broader economy,so I doubt that it will be allowed to persist.
One should also note that the housing boom was helped in part by the large numbers of illegals engaged in home building construction. They accepted lower relative wages and were always available in the quantities needed with very little trouble. Most workers on the home building sites were reported as ' independent contractors', so they never showed up in most employment reports or in workers comp/unemployment systems. That's why the initial housing crash had so little effect on reported employment levels.
I would question Schillers method for measuring inflation. Did he use cpi, or did he use M3?
The perverse economy is based upon the perverse notions of Keynes. The bankster elites have DESTROYED the US dollar, AND the US economy, AND no one has noticed.
Having 70% of GDP based on consumption, with the housing industry as a replacement for the outsourced manufacturing and service sectors is suicidal for Amerika.
Amerikan universities teach Keynes exclusively. The Austrian school of economics has an alternative view, much different than Keynes, which provides a better fundamental understanding of what is really going on.
What is most important is that real incomes have effectively collapsed. Amerika is DOOMED. Is this the "in the end we are all dead" part of Keynesianism?
Do a proper inflation adjustment, and what you will find is that we are in hyperinflation NOW.
What happened to Brasil, Argentina, Russia, is soon to happen to Amerika...