Casey Mulligan of the University of Chicago Economics wrote a great article at the New York Times today that explores the possibility that a significant portion of the housing bubble was actually justified, and that the new normal that we have reached might be some how a new normal. You really should read the entire article because it clearly dissects with a factual and reasoned bias, just how much housing prices should be.
From The Bubble Side:
Meanwhile, bubble theorists also say that today America is “overbuilt” as a result of the bubble. With too much housing and no additional demand to be supported by market fundamentals, real housing prices should, according to the bubble theory, be lower today than they were in the late 1990s.
From the Non Bubble Side
But another interpretation is that a large fraction of the housing price boom was justified by fundamentals (and next week I’ll consider some of the specific fundamentals that may have permanently increased housing demand in the 2000s). If so, we are probably asking too much of the Federal Reserve and other regulators to accurately disentangle bubbles from fundamentals the next time that asset prices rise.
I’m very much looking forward to his next installment, if this one is any gauge to the next one.
However, I’ll point out some concerns that I already have with the generic type of analysis.
1. I’ll side with many real estate agents in this in one way: Real Estate is local. Yes, you heard me right. However, this only damns places like Orange County and LA more than Inland California. While the inland areas have fallen as much as 80% in some areas, much of the coastal areas have remained priced barely below peak pricing. While the pressure in some areas is upward, much of the higher priced homes still have significant pricing problems, most notably manifested as years’ worth of inventory. Getting into Million+ homes and in some cases there are possibly decades of inventory at current prices and volume. We’d need to create a lot more wealth outside of housing to support the current prices.
2. Tax benefits are currently a major sticking point for many areas. With so much uncertainty about the future of our fiscal problems, both at a state and national level, one can expect a pretty significant overhaul in this area. Especially when considering that it would require an income substantially within the current executive administration’s definition of wealthy, and therefore fair game for further taxation.
3. I think Mulligan is oversimplifying the “bubble theory”. He assumes that bubble believers simply extrapolate based on inflation adjusted housing prices, leaving the above issues aside and ignoring the elephant in the room, credit prices (interest rates) and credit availability (looseness). There must be some factor that addresses the issues of credit, perhaps in the form of some coefficient (we can be assured that this is not 1), or as some derivative (because of the risk of selling into a restricted or pricier credit market). These mean that housing prices cannot be reflected dollar for dollar by interest rates, but rather a portion of lower interest rates while a portion goes to reward the borrower for taking on the risk of buying in a cheaper credit environment and selling in a pricier one. Few buyers consider the full 30 year or longer amortization of a loan in each and every home purchase. It is, after all, a place to live for the time being.
Nevertheless, this type of open debate means that at least we can consider the option and decide for ourselves, which if anyone remembers, is a far cry in sentiment from the bubble days of 2005 when the mere mention of a housing bubble would cause eye rolls and latent anger. I believe that there is overwhelming evidence that Coastal California has a significant imbalance between incomes and housing prices still to resolve. One has got to give sooner or later.
As a parting shot, I’ll present Mulligan’s chart which shows typical bubble theory pricing (lower than 1990′s). I’d put my own thinking a bit between both of them. I think people are still way too optimistic about housing in much of Southern California, and it’s reflected in the house prices. When it fails to deliver the goods, the actual price appreciation will need to eventually erase the “bubble gains” of the past decade.