With housing prices showing year after year of unprecedented growth across most of the United States, some have begun to wonder if housing might be in a bubble similar to the technology stocks bubble of the late 1990s. In response to these questions, the Federal Reserve has just released a new study that addresses this "housing bubble" hypothesis:
"Home prices have been rising strongly since the mid-1990s, prompting concerns that a bubble exists in this asset class and that home prices are vulnerable to a collapse that could harm the U.S. economy."
The Fed adopts the definition of “bubble” offered by Joseph Stiglitz:
"If the reason the price is high today is only because investors believe that the selling price will be high tomorrow—when 'fundamental' factors do not seem to justify such a price—then a bubble exists."
This is a fine definition for a pure market economy, in which any bubbles, manias, or panics can be attributed to the animal spirits of market participants. But we do not live in a pure market economy and the recent trends in home prices are driven in part by global, multi-state interventions in the markets for money and credit which have, among other things, created some unprecedented fundamentals for the housing market. Whether this constitutes a bubble depends upon your definition of a bubble. However, the above definition side-steps the critical issue of whether the so-called fundamentals are themselves the products of unsustainable government policies which, when they eventually fail, will create entirely different fundamentals for this asset class.
"A close analysis of the U.S. housing market in recent years, however, finds little basis for such concerns. The marked upturn in home prices is largely attributable to strong market fundamentals: Home prices have essentially moved in line with increases in family income and declines in nominal mortgage interest rates."
Yes, and home prices have also moved in line with increases in mortgage debt levels, facilitated by an easing of credit standards by mortgage lenders and an unsustainable period of low mortgage rates, which is just one manifestation of the stable instability created and maintained by central bank interventions in the markets for money and credit. The Fed's own monetary policy and its many manifestations throughout money, credit, and asset markets are the fundamentals that explain in large part why home prices have sky-rocketed in recent years. But in calling them fundamentals and ignoring its own role in creating them, the Fed implies that they are durable, time-tested, sustainable, economic bedrock. Just don't mention the fault lines and occasional tremors.
"Moreover, weaker economic conditions are unlikely to trigger a severe drop in home prices. Historically, aggregate real home prices have fallen only moderately in periods of recession and high nominal interest rates."
I would suggest that we’ve never really been through this current scenario, so a profile of past recessions is not particularly relevant. The recent alignment of central bank interventions and other economic factors that is fueling the growth curve in mortgage debt and housing prices has to my knowledge never before appeared in the US, so it would make more sense to study the current configuration and develop scenarios for how it may change in the years ahead. This graph from The Economist is at least suggestive of the novelty in our current monetary situation:
Furthermore, homeowners are not particularly interested in fictitious statistics for “real” home prices, by which the Fed apparently means objective, measurable, nominal home prices minus a fabricated index of price inflation in a basket of goods curiously devoid of homes. Homeowners care about nominal prices because that’s what they paid for their homes, that’s what they’ll get if they sell their homes, and they don’t get to adjust their mortgage balances and payments to remove the Fed’s price inflation and ease the debt burden when asset price deflation sets in.
That said, it is heartening to see in the Fed study that in past recessions even nominal home prices have not fallen too dramatically. Nevertheless, I would be interested to see an analysis that takes into consideration other factors unique to this current cycle, including the global glut of liquidity, the very low household saving rate, the prevalence of adjustable rate mortgages, the lower credit standards used by lenders, the high percentage of second home or investment properties, the popularity of housing speculation and "flipping," and the fact that home prices did not fall but actually rose in the last recession.
"While such conditions could lead to lower home prices in states along the east and west coasts—areas where an inelastic supply of housing has made home prices particularly sensitive to changes in demand—regional price declines in the past have not had devastating effects on the broader economy."
So, having concluded that the recent double-digit growth rates in home prices along both east and west coasts--which includes the urban and suburban communities in and around Boston, New York, Philadelphia, Washington, Miami, San Diego, Los Angeles, San Francisco, Oakland, Portland, and Seattle—are due for a reversal even in a standard-issue recession like the ones we’ve had in recent decades, the Fed still doesn’t expect such a “regional” price decline to have a “devastating” effect on the national economy. What a relief.
This begs the question of just what impact such a contraction in home prices along the bi-coastal "inelastic supply curve" might have if it falls just short of nationwide economic devastation. Does this mean we’re all going to be fine as long as things don’t get worse than nationwide economic havoc? Is regional economic devastation acceptable as long as it can be averaged out by incorporating another region experiencing only a modest economic set-back? Seriously, for the final bullet point in what is supposed to be a definitive refutation of the “housing bubble” hypothesis, this is a most disconcerting conclusion.
Just to be clear, I personally remain agnostic about the future of the housing market, bubble or no bubble. Preferring multiple scenarios to single predictions, I simply don't know exactly how the stable instability between market and state, among homeowners, mortgage lenders, and central bankers, between American consumers and Asian savers, will resolve itself. But I find it less than reassuring, though not at all surprising, when a Federal Reserve analysis of the situation ignores the Fed's own role in creating the unprecedented fundamentals on which this entire market trend is based.
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