In 2005, I thought housing prices were rising above the fundamentals and I said so. In 2008, as the fall in housing prices was well under way, I wrote a blog post and later a NYTimes op-ed saying that the housing price bubble was not nearly as big as people thought. I wrote:
I think that housing prices went beyond the fundamentals sometime around 2004…but 2004 levels are still well above long run trend.
…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…[with some overshooting, rather than as a bubble.]
To put it mildly, not everyone agreed with my argument. I certainly got the timing wrong–I didn’t think the recession would be as long or as deep as it was. Nevertheless, some people are coming round to my point of view. Karl Smith, for example, has a new post Was There Ever a Bubble in Housing Prices? which concludes more or less, as I did nearly ten years earlier, that the answer is no. What happened was greater liquidity which made housing prices gyrate more like stock prices but “the fundamental driver isn’t irrational bubble behavior. It is competition over a scarce resource.”
Let’s go back to the Shiller graph (now updated to 2018 with some slight corrections since 2017 post). Over the entire 20th century real home prices averaged an index value just under 100 (and over the the entire second half of the 20th century were only slightly higher at 112). Over the entire 20th century, housing prices never once rose above 131, the 1989 peak. But beginning around 2000 house prices seemed to reach for an entirely new equilibrium. In fact, even given the financial crisis, prices since 2000 fell below the 20th century peak for only a few months in late 2011. Real prices today are now back to 2004 levels and rising. As I predicted in 2008, prices never returned to their long-run 20th century levels.
Now one might argue that there is still a bubble or perhaps another bubble in housing prices. But the United States does not look anomalous compared to other countries. In fact, in many other countries prices have risen more than in the United States. Here is the Economist’s Global Price Index of real house prices for a variety of countries. (Do note that some countries not shown, such as Germany, haven’t seen big increases in prices.) Are all these countries experiencing bubbles? Or has the equilibrium changed?
Understanding why the equilibrium has changed is a fundamental issue that I don’t think we yet have a good handle on. My view, is that it’s a combination of expected long-run lower interest rates, greater liquidity, and supply constraints on land. Lower interest rates, for example, mean that durable assets increase sharply in price, all the more so if the rates are expected to stay low. Combine this with greater liquidity (see Smith’s post) and supply restrictions and you can explain most of what is going on in the United States. What I don’t know is if the same explanations work worldwide and can the same factors also be used to explain why land prices haven’t risen in Germany, Japan or Switzerland?
Hat tip: Nathaniel Bechhofer.