The Real Estate Bubble

David Bernstein provides a money supply-driven explanation of housing prices.

Around these parts (D.C. area), I've heard all sorts of explanations as to why stratospheric local housing prices (despite stagnant rents) are justified. None of them take into account the fact that prices have risen as much or more in South Florida, New York, Boston, L.A., the Bay Area, etc., not to mention Sydney, London, Brussels, Rome, etc. Clearly, it's a liquidity-driven bubble, resulting from an easy money policy instituted by world central banks. The post-Russian bond market default of 1998 caused a monetary easing, which inflated prices of securities (a form of inflation); before that liquidity bubble could be completely undone, 9/11 caused a new easing, with the inflation going into real estate instead of securities. (If rising home prices were really housing demand-driven, as real estate bulls insist, rents would be rising along with housing prices.)

Easy monetary policy was the mainstay through the mid and late 1990s despite Greenspan's caution about "irrational exuberance". As Bernstein states, that liquidity manifested itself first in securities, and since the bubble popped, in real estate. Sooner or later the real estate bubble will also have to pop, and when it does, the repercussions will be painful.

And I don't know how many times I've heard that "prices may stagnate, but you won't lose money." In 1988, a man drove up to my parents' house in Queens, and offered him 500K, cash, for his house. Four years later, it would have been difficult to get $325 for that house, and it wasn't worth 500K again until 2001.

Real estate prices in Japan dropped even more precipitously after the late 80s crash, with some properties losing up to 80% of their value. Most have not returned to their former heights even today, fifteen years later. Very few Americans believe that kind of thing is possible today in the US, and that is all the more reason to be watchful for its occurrence.


See also Robert Shiller's different explanation for the real estate bubble. Share this

Funny you mention this

Funny you mention this because in my Macroeconomics class we are required to write a paper on this. We've discovered that while housing prices have increased quite a bit relative to income, after factoring in the interest rate they are at the lowest they have been in 30 years.

cool , i'm gonna buy 3!!!

cool , i'm gonna buy 3!!!

Factoring in NOMINAL

Factoring in NOMINAL interest rates prices are less than ever. But real interest rates are much higher now that inflation has been tamed. Percentage of income would be an interesting and more meaningful metric.

I'll be happy to send you my

I'll be happy to send you my paper when it's all done and graded. Basically, since the CPI index uses housing prices, using the CPI to adjust the nominal price of housing wouldn't give a clear picture would it? So we charted out the nominal price of housing to the nominal household income. That indicated that housing prices were increasing in absolute terms. (graph here).
Next we took the nominal interest rate and calculated what percentage of annual income is spent on that and came to the conclusion that in terms of what a person earns, they are paying the least that they have payed for housing in absolute terms. (graph here)

its the same as 1975 Dave.

its the same as 1975 Dave. Your right, but bubbles are not a problem at the top. 5 years later the prices were 1/4. bubbles are a problem 3 years into the bursting of the bubble. presently you may be correct, which will be no comfort for any bubbleman-ian homeowner in 2008. its going to end up exactly like the NASDAQ japanese property wash out.:no:

Yeah, and don't forget the

Yeah, and don't forget the horrible state of Fannie Mae and Freddy Mac. Leveraged at 20 to 1. Of course, when it all blows up they will blame it on Laissez-Faire.

Brian wrote: "Of course,

Brian wrote: "Of course, when it all blows up they will blame it on Laissez-Faire."

Failing to see that central banks that wanted to fight inflation brought about that very inflation of home prices. And the situation that led to irrational decision making by individuals, like using the equity in their home to purchase cars they can't afford otherwise.

Dave Peterson: CPI uses

Dave Peterson: CPI uses rental equivalence not home sale prices and thus underestimates inflation. I guess that doesn't mean anything for your research if you're not adjusting to CPI. :)

What's the Real State of

What's the Real State of Real Estate?
One of my favorite topics to idly speculate about has become hot in recent days, starting when I saw Steven Taylor's post, positing that the situation with housing (hmmm… what about commercial real estate, and how closely are those tied toge...

idiots....er...suckers...er

idiots....er...suckers...er ...homeowners lined up for a day and a half in Vancouver to buy a $500k particle board shack in a suburb, and were quoted as saying "they wanted to get there before they were all gone" ,all financed with interest only mortgages. WHEWWW... this is an area full of cars on blocks, franchises etc. didn't people learn from the NASDAQ ripoff?

Home prices will come down

Home prices will come down proportionally as mortgage rates increase...real estate prices cycle (1975,1990,2005) and i'm prepared for the Burst. But Quest, i can't wait 3 years into the Burst...I want my house at Pebble Beach NOW.....

It is amazing ... 1/2 of all

It is amazing ... 1/2 of all new jobs in Ca. last 2 years are in real estate. 36% of all home bought last year are "investment" or 2nd homes countrywide. Estimate, of those 30% are Interest only,ARM loans..San Diego : 67% of all homes last year are IO or ARMs. ..Miami Beach: 30% of condos are sold atleast once before even being built....Anyway all the "experts" say it's not a bubble ..Ah hemm
As they say "what goes up ,must..." but hey, this is a NEW" paradigm.

No bubble here in Texas,

No bubble here in Texas, real estate is boomin. Buy all you can because the good Lord isn't makin it anymore. Yahoo!!!!

I just sold my NJ home

I just sold my NJ home because I feel this RE market has, or will top very shortly. I plan on retiring in approx. 3 to 4 years and feel if this market breaks, like it did in the late 80's,I won't be able to wait for a rebound. I saw houses decline dramatically back then. I’m moving into a cheaper house and reinvesting the equity in properties in areas I feel other "Baby Boomers" will be retiring (NC, SC, and FLA).
Hope I've made the right bet.

This country will be in

This country will be in great trouble if real estate prices drop dramatically. Legacy workers are losing a significant share of their retirement from private and government sources. These are the same workers who did not have the ability to significantly save using IRA accounts. The housing market plays a major role in the economy - it is the major portion of peoples savings / retirement. If the economy crashes so will housing or if the real estate market crashes so will the economy. Let's hope all are kept within a healthy balance. In NJ, my home has increased an average of 5% (annually) over 20 years. Gasoline prices have increased 7% (annually) over 20 years. As housing cost change (price + interest rate) expect the cost of rentals to increase. The significant amount of wealth is held by us older folks - if housing crashes do not expect these folks to rush back into the stock market. Watch out for what you wish for - you just may get it.