Do we live in a housing bubble?

by on April 18, 2005 at 6:57 am in Economics | Permalink

Housing can be lived in, most buyers have only one home, transaction costs are relatively high, and rarely are homes sold and resold in a matter of days.  All those features militate against a housing bubble.  Yet it is scary to see how high prices have risen in the Washington D.C. area.  Prices in my overall region are up 73 percent in the last four years, can houses be worth so much more?  Plus rent-buy ratios have reached apparently unsustainble levels, inconsistent with traditional assumptions about discount rates.

Let’s say you think there is no bubble, what are your options?

1. It has quickly become much better to live in good areas.  I can go to Wegman’s now.  Prices reflect this fact.

2. Traffic is getting much worse, and very rapidly.  People are paying more to be close to the action.  The price movement is lasting, though it does not reflect a true increase in real value, all things considered.

3. When you are trying to decide how much a house in worth, you also care how much other people think the house is worth.  Yet the entire slope of the demand curve is hard to observe.  The real estate market goes through a groping process.  Only as prices and quantities move does everyone realize what the market demand curve looks like.  Suddenly, over the last four years, many people have realized that many other people are willing to pay lots for a quality home.  Price has moved upward rapidly accordingly, but this need not be a bubble.

4. The higher housing price indices are a trick.  In reality some homes are worth a lot more and others are worth a lot less.  But prices move quickly in the upwards direction; in the downwards direction, housing quantity first adjusts and stays slow for a long time.  That is, if you can’t sell your family hearth in Kansas for a decent price, you simply wait for now.  So overall indices appear high but much of this move is a sectoral shift within the housing market from low quality to high.

I put the least stock in #1 and the most stock in #3 and then #4. 

I am not yet convinced there is a housing bubble.  But since I bought close to the peak — had to buy close to the peak — perhaps I am deluding myself.

Addendum: Here is my earlier post on the topic.  Here is Alex.  Here is Brad DeLong.  Here is some Austrian economics.

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