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.
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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.
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.
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?
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.
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.
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…
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.
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.
Alex,
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.
Any updates Alex?
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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You have a way with words, but remember by and large, language is a tool for concealing the truth
You have a pretty good chance from what I see. Your course load is hard but why dont you have a math class senior year? It doesnt really matter but you are still good in the SAT department. I would try to take them over again just to get your writing score up.
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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