Was there a Housing Bubble?

by on February 13, 2008 at 7:45 am in Economics | Permalink

The conventional wisdom is that there was a housing bubble which has now popped.  The data, however, tell a different story.  Remember, that the evidence for the bubble was that real house prices had increased tremendously since around 1997 leading to prices that were far above any seen in the past one hundred years.  Here's Robert Shiller's famous chart.
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.

Here’s a nice picture from The Mess that Greenspan Made.Case_shiller_index

1 Kevin Miller February 13, 2008 at 8:14 am

Save this post, so that you can look back on it in later years. It’s a bold prediction to make right now…hope you’re right!

2 Peter February 13, 2008 at 8:26 am

I don’t think I know enough economics to have an opinion on this, but I have a couple questions for those that do:

1. many people seem to expect above-trend inflation over the next 5-10 years; how would this change the visual effect here? I assume it would compress the whole graph vertically, but would it have a disproportionate effect on later/earlier periods? For example, I’m trying to picture (and can’t) what this graph would have looked like in 1970, shown in 1970 dollars instead of today’s dollars. Would that postwar spike have seemed even more prominent?

2. i think i have a general understanding of hedonic effects, and some differences between a “standard” house today and at the beginning of the graph are obvious — but it seems like the average American house has gotten nicer (better appointed but especially bigger) much faster than the standard of living has risen over the last ten years or so. If this is true and it’s part of what was going on in the “bubble,” what does it say about that graph? For example, should we be drawing it on a per-square-foot basis like we would for commercial real estate?

3 Winslow Theramin February 13, 2008 at 8:31 am

Was the WWII up-swing a shift to a new equilibrium, or a shift back to the pre-WWI equilibrium?

Take a look at the last 10 years of the NASDAQ as a reminder of how far things can fall.

4 Mark February 13, 2008 at 8:54 am

“Prices will probably drop some more” way to step out on a limb here.

I fail to see a connection between any evidence you’ve presented and your claim ‘there was no housing bubble’. So prices will ‘probably drop’ while there absolutely was ‘no housing bubble’.

Correction from a bubble this severe is certain to be measured in years. What sort of further price depreciation are you forecasting that you can make such a claim and what are your assumptions? All I see is a graph showing history of a correction well underway.

Of course, what do I know? I’m just a Credit Snob who thought that tighter regulation was the answer.

5 Ziggurat February 13, 2008 at 9:16 am

It has all the signs of a bubble. There is significant inventory overhang, including new homes, resales, and just coming on line, repos or bank REO. Numbers of sales are declining. People in non bubble areas are keeping homes off the market unless they are forced to sell, creating a hidden inventory. Ratios of prices to income are at record high levels. It is significantly cheaper to rent to buy in bubble markets. Yes it’s now conventional wisdom, but if you want to question it, some serious data would help. There is all the evidence you could want plus more at the blog calculated risk.
We won’t be out of this until residential housing no longer seems like an ‘investment’ — let alone a good investment. I would say right now, most people feel like houses will be nominally more expensive in 5 years then today. Until people think of a mortgage as an anchor and houses as consumption, we won’t be out of it.

6 Floccina February 13, 2008 at 9:50 am

I think that country and local government slow growth policies and other regulations play a role in keeping supply down which can cause a price spike if interest rates fall.

7 Jeff February 13, 2008 at 10:06 am

I think the run up was caused by a combination of low interest rates and tax law changes enabling people to move without worrying about capital gains.

I also agree with the commenter that the lack of liquidity in the housing market causes it to take a long time to adjust to new prices. This would process will quicken if we get higher interest rates.

8 Cliff February 13, 2008 at 10:22 am

Alex, how much do you stand to make on the bets you placed on the prediction markets that housing prices won’t go down much more, since you seem pretty confident of that?

9 bronxilla February 13, 2008 at 10:27 am

That new homes are getting larger may be true in some parts of the country, but definitely not here in New York City, and presumably in similar congested urban areas. You are definitely getting less square foot per dollar for new homes in New York.

10 odograph February 13, 2008 at 10:31 am

Shiller did a good job catching the housing bubble before it popped, and explained it at length in the early editions of his book “Irrational Exuberance.”

I think the main problem with your chart though is that certain things become more meaningful when adjusted for “inflation” and some less so. We know those “constant dollars” (a) have less meaning when comparing a horse-and-buggy economy to a modern one, and (b) are recursive (when inflation is housing and housing is inflation)

A better bet would be for you to chart median home prices against median income. That’s an easy way to separate the inflation issue (it should apply equally to wages and housing).

So how have median homes fared against median income in the last 100 years?

(Not the “mea culpa on debt” I was looking for 🙂

11 J February 13, 2008 at 10:38 am

In order to maintain those higher values, it would mean a sectoral shift in demand, whereas a bubble would imply a temporary increase in quantity demanded.

The best I can reason is that:

1. The dropping of mortgage interest rates led to permanent decreased cost of ownership, shifting a great number of those who were on the bubble of renting to home buying. While a small number of those first-time buyers used ARM’s and over-purchased, many others took advantage of low fixed-rate mortgages. This would shift demand permanently instead of just moving along the curve, raising prices.

2. The above phenomenon also created a bubble in addition to the long-term change, allowing people who already owned homes to relocate cheaply. Some buyers may have even moved more than once, driving up prices in the short term. Since the market has cooled, they will not settle, so this should lower prices.

3. Interest free mortgages and increasing prices led to increased investment in the housing market, which would only have a short-term increase in prices. As the market has cooled, investment has shifted away from the housing market, which should also lower prices.

But that last chart pretty clearly indicates that there WAS a bubble. The data ends in 2006, and in 2007 we see a decrease in prices. While these prices are slow to fall, I believe they will slowly drop until they catch back up with the inflation rate or another mortgage phenomenon takes place (mainly because housing is not just an investment but also a useful and necessary good).

12 John Dewey February 13, 2008 at 10:41 am

I agree with Floccina. The metro areas with the largest run-ups are the ones where local governments restricted supply. Randall O’Toole’s Thoreau Institute blog explained three years ago how smart growth was fueling housing bubbles.

Smart Growth and Housing Bubbles

Dallas, Houston, and Atlanta – three relatively unregulated metro areas – have not experienced the housing bubble, despite growing the most in population during this new century.

Here’s another passage from a more recent Randall O’Toole essay:

“While housing prices grew by more than 130 percent in California and Florida from 2000 to 2006, prices in Texas grew by only 30 percent. With few exceptions, the states that saw the biggest bubbles were ones that had passed growth-management planning laws. And with one exception, every state that has passed such a law also saw a housing bubble.”

Paying the Planning Tax

13 nelsonal February 13, 2008 at 10:56 am

Don’t forget to adjust the lower graph for inflation, those drops from mid 06-07 would probably be 10-15 index points after taking 4% more for inflation (that would bring real prices back down pretty quickly).

I’d argue that there is some real adjustment in home prices necessary post 1997, to account for the capital gains exemption in home prices, but I don’t think it’s 100%.

I do expect that we’ll see values in the low 100s (110-130) with a likely overshoot for a few years, too. But I’d guess that inflation will be more of a factor than nominal declines.

14 Houser February 13, 2008 at 11:01 am


Less restricted building in areas like the OC or NYC would involve larger and more plentiful vertical buildings. Look at Hong Kong for an example of how to pack housing units into a small area.

15 cure February 13, 2008 at 11:09 am

Ziggurat is right – there has been a massive increase in homeownership that is tough to justify with demographics alone, the rent/buy price ratio is completely nuts at the moment, etc. If you want to claim this isn’t a bubble, look at the pattern of house prices in true bubble markets like early 1990s HK and Japan. Housing prices didn’t drop 50% (as they would eventually do) overnight because, for reasons mentioned above, there is some downward price stickiness in housing.

Look at some of the most expensive markets, where the median household can afford 5-10% of the houses on the market. What would make you think this is sustainable? At some point, budget constraints bind.

16 odograph February 13, 2008 at 11:36 am

Houser .. OC did indeed “go vertical” in a big way last year. Unfortunately it coincided with a bubble ..

first high-rise foreclosure makes news

17 Donald A. Coffin February 13, 2008 at 12:01 pm

All the evidence I’ve seen suggests that the price elasticity of supply of housing is huge–estimates seem to range between about 3 and about 10. This suggests that a permanent increase in the price of housing will lead to a massive increase in homebuilding. And, indeed, the extraordinary expansion of activity in residential construction from 2000 to 2005 supports this hypothesis. I think housing prices will fall, albeit slowly, back to that trend level, precisely because of the supply response.

This will be less true in highly congested urban areas (midtown Manhattan, San Francisco, maybe some others), but where there’s space, the new construction will pull things back.

18 Donald A. Coffin February 13, 2008 at 12:08 pm

All the evidence I’ve seen suggests that the price elasticity of supply of housing is huge–estimates seem to range between about 3 and about 10. This suggests that a permanent increase in the price of housing will lead to a massive increase in homebuilding. And, indeed, the extraordinary expansion of activity in residential construction from 2000 to 2005 supports this hypothesis. I think housing prices will fall, albeit slowly, back to that trend level, precisely because of the supply response.

This will be less true in highly congested urban areas (midtown Manhattan, San Francisco, maybe some others), but where there’s space, the new construction will pull things back.

19 odograph February 13, 2008 at 12:32 pm

Now cars all sold on the monthly cash flow hit, which increased affordability and a lot more cars are sold and leased.

I, the stubborn cash buyer, am not sure this is a good thing. It coincided with a collapse of personal savings. It’s as if we (ooh, this is good) we live care-free in a welfare state. We don’t need to worry about our own future or economic responsibility.

Because in the new capitalist welfare state they’ll just zero out interest rates and make everyone good again.

20 mickslam February 13, 2008 at 12:55 pm

I can set alex up with people who would be willing to do OTC swaps of any size on real estate prices.

It is very early to be making claims like this.

You can get better realtime data from the Radarlogic site.

21 Hedgefundguy February 13, 2008 at 1:21 pm

Alex – US housing prices became rich to incomes and rents, but the real bubble was a global bubble in credit. Credit expansion had very significant Cantillon effects, and the run-up in US home prices was just one manifestation of this. That supported domestic US consumption in the face of weak income growth and – given declining domestic manufacturing capacity – led to a current account deficit. Given currency pegs of Asia ex Japan and OPEC the counterpart of US current account was fast domestic monetary growth and accumulation by foreign official insitutions of US assets (particularly Treasuries).

Note that lower rates lead to a one-shot increase in desired housing stock and equilibrium prices. If entrepreneurial agents should mistake this one-time shock (adjustment to equilibrium being spread out over several periods) for change to ongoing flow then you will see a cluster of errors when the music stops…

22 laughCat February 13, 2008 at 1:45 pm

I am definitely going to print this one out and send it back to you in two years or so. I know you folks are constitutionally unable to grasp the scope of the collapse that is occurring all around us (I visit here to check my pessimism when it gets too deep). But, to say there was no housing bubble . . . zoiks . . . I do expect a regression to 110 or so.

23 russ February 13, 2008 at 2:08 pm

Aug 12 2005

Memo on the Margin

There is No Housing Bubble!!

Memo To: Website Fans, Browsers, Clients
From: Jude Wanniski
Re: Nothing to Worry About!!


24 TGGP February 13, 2008 at 2:28 pm

Karl Smith asks whether it was a housing or credit bubble here, and explains the difference between the two.

25 BayAreaIdiot February 13, 2008 at 3:45 pm

I enjoy reading your blog but not for its entertainment value. Until now that is. The fact that you would allow yourself that last “in italics!” statement is nothing if not hilarious! Keep it up!

26 Rory February 13, 2008 at 4:11 pm

Let me guess… you bought a house in the last 4 years.

27 Lintel February 13, 2008 at 4:30 pm

Housing derivatives markets that use the S&P/Case-Shiller Index and the radar Logic RPX Index are showing 25% declines in housing prices over the next five years. A 100% retracement is probably not going to happen, back to 1996 levels, but these derivatives are showing that big declines declines are in the offing.

28 JB February 13, 2008 at 4:43 pm

I’m surprised nobody (from NYC at least) is mentioning this (taken from the case-shiller FAQ)

2. What types of homes are included in the index calculations?
To be eligible to be included in the indices, a house must be a single-family dwelling. Condominiums and co-ops are specifically excluded. Houses included in the indices must also have two or more recorded arms-length sale transactions. As a result, new construction is excluded.†

It is preposterous to use this metric to determine what is going on in big cities, specifically manhattan. They do not include co-ops and condos, so essentialy it does not include any manhattan real estate.

The lesson as always — real estate is CASE (no pun intended) SPECIFIC and too hard to just say “oh the HOUSING MARKET is going up or down”. The “HOUSING MARKET” doesn’t really mean anything. Compare that to the “(stock) MARKET”. That is a tradeable instrument. You can buy SPY or QQQQ and “get long or short the market”. You cannot just “get long or short the stock market”. (and yes i know there are derivatives on the case-shiller, but they don’t trade and are a joke in the finance community).

29 JRip February 13, 2008 at 5:19 pm

So – NO Bubble – this is just a correction? a shift to a new equilibrium?

Earlier this week…

Question for Treasury Secretary Paulson about the mortgage and credit mess:

Q for Paulson: Is the worst over?

Paulson: The worst is just beginning.

30 marmico February 13, 2008 at 8:04 pm

If you are going to utilize Iacono’s Case-Shiller chart, at least use an updated one. You are three months in arrears in the housing bust.

31 travis February 13, 2008 at 8:53 pm

This is an inane, evidence-free argument you are making, particularly at the very start of the bubble bursting. Over the last ten years, houses were being mortgaged with unprecedented loan-to-value and loan-to-income numbers, numbers that violated decades of banking experience. As the folks at Calculated Risk pointed out yesterday, you can easily create a affordable mortgage for 13x your income by using all of the high-risk options (ARM, IO, payment optional). But if you convert that fancy loan back to a vanilla 30y fixed, the payments are 84% of your gross take-home income.

People can’t afford the new houses without using the new instruments (newly popular, anyway). The new instruments don’t work without a continuous cycle of refinancing or actual sales. Homeowners are now boxed in by a harsh reality. Prices will drop massively, as they have already just started to do. The large inventory build-up already shows a mismatch between buyer and seller expectations.

32 Bodz February 13, 2008 at 9:14 pm

Reply to Anthony:
A lot (maybe most) of the people getting foreclosed in California, Florida, and elsewhere are going to rent now at less than 50% of what they were paying for their house.

33 Cliff February 13, 2008 at 10:07 pm

Anthony, please post some evidence or don’t post at all. I have read countless threads examining the total costs of renting versus home ownership in various markets (YES taking into account obvious things like size) and renting (and investing the difference) usually comes out ahead, especially if you’re not sure you will live in one place for ten years or more.

34 Bodz February 13, 2008 at 10:35 pm

A lot of the people getting foreclosed in the bubble areas of the country are choosing to voluntarily walk away from their house. In many instances they could rent the same exact house for less than 50% of what they were paying for it (mortgage, insurance, taxes, etc.) They did not mind this imbalance when they brought their house because they thought that their house would apreciate 20% a year forever. But now, that prices are falling, they want nothing to do with their house. There was an article in WSJ yesterday http://online.wsj.com/article_print/SB120276871472760255.html?ref=patrick.net
about how, even after falling somewhat, prices are still, by historical norms, wildly overpriced in California (by 40%).
If you bought a house anytime in the last three years and don’t end up in foreclosure, you will enjoy your house but live like a miser for the next 10 years.

35 benny lava February 14, 2008 at 12:37 am

Brennan — is the set all owners? I expect so. Long time owners would benefit greatly from the decrease in mortgage values (assuming they refinance or otherwise get the benefit of lower rates.) New buyers (since, say, 03?) are spending much more than that on their mortgage. And yet prices are set in the margin, so the folly of the past few years makes the home values of long term owners go up while their payments go down. So that subset sees a decrease in that percentage, which is probably the bulk of the set, yet there is a significant proportion that is a huge outlier to that.

Add to that lines of credit and other debt that has been premised on rising home values and “the wealth effect” and I expect overall the debt service proportion of income has skyrocketed. It’s housing, it’s debt, it’s lack of savings, it’s falling nominal “wealth” for those that bought in the past 5 years. It’s a shock of pretty significant proprtions, no matter what you call it.

Come to that, I’m not sure anyone has set the terms anyway, not least Alex. What’s a “bubble”? What are we talking about? How significant does the downturn have to be to be a bubble that has popped? A 25% real loss in value — after inflation, thats about, what 5% a year for 3-4 years? — brings that index down to 150. Pretty steep looking decline, and that kind of loss in value is not that farfetched.

I think you’ll be eating this post later, frankly.

36 James A. Donald February 14, 2008 at 2:14 am

I say that the price of detached houses will rise without end, a million, two million, ten million, until the day that people start building houses illegally on land for which no permission to subdivide has been given.

Government could create a sand shortage in the sahara. What we have now is a shortage of permission to subdivide, which shortage can never improve, can only get worse. So prices must rise, rise, rise and rise some more till people start defying zoning laws.

37 Anthony February 14, 2008 at 9:59 am

“I have no doubt you could rent THE SAME HOUSE for 50% of what you could own it for in some areas of California, and yes I know people doing this.” Not if you compare it to a negative amortization mortgage with no money down, which would be the equivalent of renting (rent payments go *up* over time, and you never build any equity renting).

38 benny lava February 14, 2008 at 11:04 am

Anthony, most normal people wouldn’t be so radical as to actually sell their homes simply to book a profit. For most people it’s a home first, and investment second. Factor in upheaval, transaction costs, moving costs, plus some risk that their market assessment may not pan out as they think. Part of the whole problem has been that home ownership has been this vehicle to rapid wealth, (and leverage for consumer debt), with many bad decisions made as a result. Your “sell and rent” is simply the flipside of that folly.

39 Anonymous February 14, 2008 at 11:54 am

Here’s a Wall Street Journal article about the difficulty of even measuring house prices… it’s tougher than you’d think, and the two major indexes measure in slightly different ways and come up with different results.

40 Rich Berger February 14, 2008 at 1:22 pm

According to Shiller, his index (which is inflation adjusted) went from 100 in 1890 to 199 in 2006. I calculate an annual increase of 0.6% per year. That seems very small given the incredible improvement in housing over that time (size, appliances and heating, cooling and electrical systems).

41 SoldAtTheTop February 14, 2008 at 2:11 pm


What argument are making? This is just your hunch… I don’t see a single analytical argument.

The housing decline is a slow process with heavy momentum… homebuilders (the professionals) started slashing prices this summer in fire sale activity… homeowners (the novice seller) is just now cracking under the tremendous psychological pressures coming from the housing-credit debacle and looming recession…

Prices will continue to decline for at least 5 years… where they end up we will have to wait to see but in all past housing downturns prices “over-corrected” as sellers seriously capitulated during the main price “free-fall” phase…

We are in the price “free-fall” phase now…

42 Anthony February 14, 2008 at 2:50 pm

“I’m countering the point that rent is money thrown away and you can’t build equity by renting.” Well, you *can’t* build equity *by* renting, though you can build equity *while* renting. Is rent (and interest) money thrown away? I think that’s a semantic argument, and not one that I raised (I never said rent was money thrown away).

“But if you own a home worth 175k that would rent for 1500, well, the numbers are fine. Trouble is in a lot of markets homes that are worth double or triple that rent for that much.” I live in Tampa, Florida, which is on pretty much all the lists as an example of one of the most prominent places where there is/was a housing bubble. This same house sold in 2003 for $134,000. So if there isn’t a housing bubble here, I have a hard time seeing where there is one. I hear Los Angeles is/was bad. But we’re talking here about a national-wide bubble.

“And I think you’d be a fool to give up your home for chump change like $50 grand.” If “$50 grand” is chump change to you, you probably live in a house worth more than $200K.

“My point was the unwinding could take years, even decades, it could stall, have false bottoms, little spurts of markets rising, who knows.” That raises an interesting question. If nominal housing prices don’t actually fall that much, but there’s a real drop due to inflation, can you even call it a bubble? I’d say no, especially since the purchases of those homes were tied to incredibly low-interest-rate loans (and that’s something we still have, the 10-year bond is at 3.81%). Without the house, you can’t get the loan. That does seem somewhat unfair though, if the fear of a housing market collapse creates the fed moves which create the inflation.

43 Dave February 14, 2008 at 3:44 pm

This analysis is about as lazy and superficial as something I’d find in a Google Finance forum. First, your data is old – the CS index recorded an 8.4% YoY real decline in Jan ’08. But more importantly, you fail to even mention the presence of downward price stickiness that suggests sharp future declines (which anyone in the RE business will attest to), the unprecedented inventory glut and homeowner vacancy rate, wave of mortgage bank failures/mortgage derivative write downs, the sharp uptrend in delinquency rates, home starts, completions, and transactions diving off a cliff, and homebuilder confidence at historic lows… you know, all the things that serious analysts of the market tend to look at. Please do us a favor and educate yourself by reading Calculated Risk’s Jan 08 Real Estate news letter, or more generally by occasionally reading the number of quality blogs that regularly cover the RE market. And before Marginal Risk feels inclined to opine on anything outside its normal purview, remember:
“Better to remain silent and be thought a fool than to speak out and remove all doubt.†

44 meter February 14, 2008 at 4:21 pm

Here is the NY Times rent vs own calculator:


45 Bodz February 14, 2008 at 5:17 pm

Dave posted: you fail to even mention the presence of downward price stickiness that suggests sharp future declines (which anyone in the RE business will attest to)

Mumble Jumble. Dave, you don’t know what price stickiness means, do you? Please do us a favor and educate yourself first.

46 Rick February 14, 2008 at 8:15 pm

I am old. When I was young and engaged in primal physical activity with females, it didn’t occur to me that most of them didn’t achieve “satisfaction.” I was gifted with the ability to take as long or as little time as I wished. Unfortunately, I didn’t know that it takes females, on average, a lot longer to “get there” than it does males. Hopefully the analogy is tactful enough; nevertheless I believe it apt: you have not given the market enough time to collapse, as it surely will. People will stretch to their last dollar/pound before giving up and waking away. It is coming. You finished early, as I did when I was young.

47 Cliff February 14, 2008 at 10:21 pm


We have agreed that for those planning to live in a home for less than 10 years, renting is often better than buying. We have agreed that in some areas renting costs less, on an immediate monthly basis, than buying. Your argument appears to be that no one is better off renting than buying and living in a home for 20-30 years or more and because owning is cheaper than renting, there can be no bubble.

There are many problems with this argument. One is that it is based on the assumption that the price of owning a home has to be systematically overpriced compared to the price of renting for there to be a housing bubble, which is not obvious to me. Two is that it ignores the probably majority of people who can not reasonably plan to live in the same place for twenty years or more. A third is that you _can_ come out ahead by renting for 30 years or more.

I would say that the fact that housing prices in some areas appear to have priced in an expectation for large future price appreciation is an indication that there was a housing bubble. You can tell because the price of owning, without considering price appreciation, is higher than the price of renting for most people. Neither of us have the data to prove or disprove that point, but I think I can cast some pretty significant doubt on your conclusion that you will always or almost always come out ahead buying and “holding” for 30 years.

What you are ignoring in your calculation is that the difference between rent and housing costs now (including the down payment and closing costs!) can be saved and invested and may make up for any inflation in rent relative to the price of owning a home. Not having to make a down payment is a huge factor that often makes the difference. A down payment now is way more than the present value of not having to make payments 30 years from now, which is approximately zero (seriously). Clearly whether you come out ahead renting depends at least on the the relative costs now and the length you stay in one place. Rent will increase with inflation, but so will homeowner’s insurance, maintenance, utilities. The fact that you discount maintenance tells me you have little experience in the matter. Replacing a roof, A/C, heating system etc. is expensive and those are all things you _will_ have to do if you keep the house 30 years as you propose.

Let me run some simple calculations to show you when you may come out ahead, even after 30 years. As an example, like you I will use my own area. My rent is $1160/mo. The cheapest comparable condo lists for $300k. Lets say you get it for 280, with a 20% down payment and 5.7% 30-year fixed. Down payment is $56k. Closing costs are $5k. Payment is $1300/mo. Condo fees are $200/mo, insurance $60/mo, utilities I don’t pay for at my apartment and maintenance total $110/mo. So first year, annual cost for renting is $13920 and for owning is $20,040. After that, rent rises with inflation (4%) and non-mortgage payment owner costs rise with inflation (4%) while mortgage payment remains the same. Assume 6% real rate of return for a 10% discount rate. Around year 14 owning becomes cheaper. In total, the cost discounted to present value after 30 years of the monthly expenses is $228k for owning and $208k for renting. The house value rises with inflation (remember, no appreciation) and its present value at the end of 30 years is $52k. Add in closing costs and down payment and the total cost of owning is $237k, while the cost of renting was $208k.

All that ignores the many advantages of renting including low transaction costs that allow you to easily upgrade or downgrade or move as your circumstances change. Even if you play with the numbers quite a bit, renting is still better. Clearly there are many times when renting is superior.

48 Kaitain February 15, 2008 at 12:41 am

What the hell?
This is an ARGUMENT? Where? I don’t see one. I mean, seriously:
“Prices will probably drop some more but personally I don’t expect to ever again see index values around 110. Do you?”
That’s IT? That’s your knock-down blow – an appeal to people’s gut instinct intuition?!
As people have pointed out above, the post-WWII move is a return to the previous equilibrium level after 25 years of global strife, not a ratchet move to a new equilibrium.
This is a non-argument. There is nothing to see here.

49 Anthony February 15, 2008 at 10:32 am

“Assume 6% real rate of return for a 10% discount rate.”

Absolutely not. I can borrow from my credit cards at less than 10%. I can buy options with implied interest rates at less than 10%. I can get a 125% home equity line of credit at less than 10%. I can borrow on margin at less than 10%.

As for your assertion that “most people cannot get 95% loans with no PMI at 5%”, I’m not sure that’s true – I believe most people, at least when not in a credit crunch environment, could get such loans, if only they looked for them. Certainly they could get an 80/15/5 with a rate on the home equity portion less than that 10% rate of return you claim. Speaking of which, is that before or after taxes?

“Your argument appears to be that no one is better off renting than buying and living in a home for 20-30 years or more and because owning is cheaper than renting, there can be no bubble.” Not “living in a home”, “owning a home”. Otherwise, correct. You can’t call it a bubble if the asset is undervalued.

50 Cliff February 15, 2008 at 12:15 pm


That is your only response? You are basing your entire argument on your certainty that stocks will produce significantly less than a 6% real return?

You really think it’s so improbable that stocks will return slightly less than their historical average or better over 30 years and that destroys my argument? What discount rate are you using? My inflation rate estimate is very conservative.

As I said, you can change things around a lot without the results changing. How about 2% inflation and 8% discount rate? You really think stocks will return less than 8% over a 30 year period? It makes me laugh that you suggest houses are undervalued generally speaking. I want to hear what numbers you have to use to make it better in my scenario to buy and own. My guess is that they are far from accepted.

And we are talking about the most generous scenario for owning (owning your house forever) and ignoring the many benefits of renting and the people with less than perfect credit or who cannot expect to stay in the same place over thirty years.

As I said, I think I have cast significant doubt on your assertions.

51 Hedgefundguy February 15, 2008 at 4:04 pm

cb – “Given that Asian currency regimes haven’t changed and oil producing states are still accumulating $’s, what is it that has changed?”

The Asian + OPEC currency regimes _have_ changed – at the margin they are buying fewer US Treasuries and more risky and non-dollar assets. The rise of the Sovereign Wealth Funds is just one expression of this change in reserve management policy. Unfortunately the US hasn’t been all that welcoming to certain kinds of inflows. One impact of such a policy change is to increase term premium – the low levels of which (as measured by the 2s10s swap curve or the 2-10-30 butterfly) gave rise to the conundrum. (One may note with some amusement that the ‘conundrum’ gained its peak coverage just as it was going away).

What’s really changed though is risk appetite and economic confidence. Why was it that in Feb 2007 all the investment bank economists and policymakers were congratulating themselves for having achieved that rarity – world firing on all cylinders? Not a cloud in the sky – yet a few months later the picture looked very different. Well economic confidence has by definition a non-rational component subject to ebbs and flows of its own. The human tendency to attribute a favourable run in economic outcomes to high quality economic and corporate management never ceases to amuse me.

By the way, economists are notoriously lousy macro forecasters at turning points (where the money is made!) and the thinking of great macro investors is rarely in line with conventional academic wisdom about macroeconomics. Wall Street collectively has never forecast a recession before it occurred. One is part of the crowd and therefore inescapably affected by mass psychology and irrational influences on confidence. Economists are as bad as anyone in attributing their own sense of confidence (or otherwise) to ‘fundamentals’. To make money you have to see beyond that – anticipate shifts in confidence before/as they occur.

” The current re-pricing of risk has just shifted funds out of riskier products to less-risky, the funds still have to be deployed, and looking at exchange rates, it doesn’t look like it’s leaving dollars.”

When assets are repriced in such a massive way, it’s less about large selling by informed and savvy participants and more about an evolution in beliefs and swing in sentiment of the pool of existing and potential holders of the asset. There is just no bid for CDOs, so the perceived value was illusory – the existing funds aren’t there to be reallocated to other products.

The dollar often does well in a recession – if consumption slows and the current account (flipside of net private and government dissaving) starts to improve this will reduce the need for capital inflows to fund the deficit. Investors have also set substantial strategic overweightings of international assets and an unwind of this will be dollar supportive. Bigger picture though, although a dollar bounce is possible, prospective likely scenarios for joint fiscal and monetary policy are very bearish for the dollar against real assets.

52 Ryan Petersen February 15, 2008 at 11:46 pm

Why should we ignore the cost of new construction when looking at housing prices? Isn’t that the replacement cost for the existing housing stock? With building materials at record highs, thanks in large part to the rise of China’s economy (which isn’t going away anytime soon), it makes sense that housing prices have skyrocketed in recent years.

53 Anthony February 16, 2008 at 8:56 am

Ah, here we go: My credit union has a variable rate home equity line of credit set at the prime rate for up to 100% LTV. Can we assume that the prime rate will, on average, be significantly less than 5% above inflation? I definitely can’t let you claim a rate of return on investments above the prime rate. And after taxes I can’t even give you that.

And out of curiosity, would you recommend I take out a HELOC at this prime rate and invest it in the stock market? Isn’t that the kind of thinking that got us into this mess in the first place?

54 Khyron February 17, 2008 at 4:45 am

Isn’t the key that prices were a rocket heading up but are a feather heading down?

Due to the liquidity issues of housing, transaction costs, marketing times, other frictions, and the plain emotions of the housing market — stuff that’s been well documented in other places — I think its unreasonable (at best) to expect prices to plunge. Houses will come off the market, for the people that can stand to stay put. In the case of foreclosures, you’re looking at 90 days just to get to the NOD, and then you have to keep in mind the lags in reporting all this public data. I don’t think its quite as simple to say that “there was no housing bubble” because the prices don’t come down as quickly as they went up. The housing market isn’t that dynamic; otherwise, it would be the stock market, right? There’s less liquidity, more friction, and its a lot more personal for people, as we don’t live in our stocks, or re-model our stocks with our favorite color paint, etc.

Also, keep in mind that your FL, NV and CA markets that had the highest appreciation rates will suffer the most on the downside, but not exclusively. Look at Detroit. Or Cleveland. Neither had excruciating appreciation, if any, but they are among the top sufferers on the downside because the local employment markets have sucked and will continue to suck, and that was happening during the housing bubble!

I think its a bit disingenuous to make this argument.

55 Benjamin February 20, 2008 at 1:01 pm

These arguments are entirely unpersuasive. Mr. Tabarrok says simply that even though prices have gone down, they haven’t gone down enough by February 13, 2008 to merit a genuine bubble. Astonishingly, that’s as rigorous as his analysis is.

His arguments are not based on market fundamentals, such as household income, interest rates, current housing inventory, new housing starts, or home builder data, but simply based on a graphical analysis of the charting data. You’d think that if he’s so graphically inclined, he’d at least acknowledge the massive price spike of the last few years. Tabarrok misses the obvious fact that real estate downturns play out over years (Japan’s real estate prices went down for 19 straight years), and simply pronounces “a new equilibrium.” He sounds like a dot.com pundit of 1999 saying there’s “a new economy.”

While a 2 decade long depreciative cycle in the United States is unlikely, it is clear that over the long-term, people pay their home mortgage with their income. And currently, there is no income support for current price levels in many U.S. cities. Hence mean reversion will come.

56 Uncle Jeffy February 22, 2008 at 4:01 pm

Are you familiar with the concept of anchoring? If you expect prices to come down as rapidly as they went up, you’re deluding yourself.

Incidentally, I just put a reminder in my Outlook calendar to e-mail Battlepanda in 2010 so that s/he can check on how your predictions worked out…

57 David Sucher March 13, 2008 at 7:55 pm

Why should housing be in long-term decline when there is a global shortage of natural resources? Does anyone actually think we have too many houses? In some Platonic sense? Houses are not dpot-com speculations but are really physical things where people can live.

The problem is that the incomes are not high enough to pay for that housing. But the housing is physically there and after a decline of some level — and that’s the huge question — all the housing will get used.

58 klarek March 18, 2008 at 3:56 pm

Your supporting arguments for prices not falling back to or below their equilibrium level are:

1. That they’re not there yet, and
2. That post WWII prices leveled off above the previous equilibrium.

That is neither a compelling nor even slightly serious argument and is contradicted by just about any market-related indicator in existence.

59 James June 26, 2008 at 6:52 pm

One of your mistakes was mixing and matching real and nominal graphs. Real housing prices are currently forming a pretty nice bell curve. I have a feeling that in five years’ time this post of yours will make you look like a fool.

Here’s a better graph than the second one you used. http://mysite.verizon.net/vzeqrguz/housingbubble/

An economist who cannot recognize an asset bubble at its peak is one whose Ph.D. is not worth the paper it is printed on.

60 theCoach October 19, 2008 at 9:40 pm

Any updates Alex?

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Well, one year later, it looks like Mr. Shiller is pretty close to being correct. If you can still see through the egg on your face, I would suggest reading some college level Economic books would provide real education on law that are immutable. By 2010, my guess is that by 2010, Mr. Shiller will be totally vindicated. If you want learn more about real estate, please visit my Web site.

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65 AMW February 22, 2011 at 4:21 pm

Well, I don’t want to say “the results are in” or anything, but we now have a little over 3 more years of data since this was originally posted.

The bad news for your theory is that the index is down about 33 points since you posted, to 142.42 from 175.96. There was definitely a bubble.

The good news for your theory is that the index has been in the 140 neighborhood for about 2 years now. So maybe we are at a new equilibrium. Or maybe we just haven’t seen the end of falling house prices. I suppose we’ll know in another three years.

Stay tuned.

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