As the housing bubble starts to unwind people will be looking for villains in this economic disaster. There are many, with the list including Alan Greenspan, the bulk of the economics profession, and of course, the reporters covering the housing market. As was the case with the stock bubble, there was very little attention paid to the underlying fundamentals in the market. Anyone who bothered to look at the data could have quickly recognized that the run-up in home prices in the years after 1997 had no historical precedent. From the early 1950s until 1997 (the years for which we have good data), house prices largely followed the overall rate of inflation. In the years since 1997, house prices have increased by 50 percent after adjusting for inflation. If housing prices have tracked the overall price level for 50 years, and then suddenly take-off relative to other prices, this is a fundamental change in a key sector of the economy. Fundamental changes in the economy are not impossible, but they don't happen very often. Unless there is very good evidence, it is reasonable to assume that there has been no fundamental change. In this case, that means assuming that the run-up in house prices is a bubble and will be reversed. I have debated most of the key actors in this debate and none have given an explanation for the run-up in house prices that passes the laugh test. They would say things like people value the security of homeownership, that homeownership is the American Dream. Did this first become true in 1997? There is a limited supply of land and many of the areas with the most rapidly growing housing prices are uniquely attractive places to live. Did New York, Boston, San Diego, Washington, and San Francisco first become nice places to live in the late 1990s? Environmental restrictions have limited the supply of new housing. Did environmental restrictions become stricter after the Republican takeover of Congress and many state houses in 1994? If they did, why has homebuilding been going on at a near record pace over the last 4 years? Immigrants are pushing up the demand for housing. How many recent immigrants are buying $450,000 homes (the median home price in places like San Francisco and Boston)? More importantly, didn't we just have a national debate over Social Security, the main premise of which was that population and labor force is growing slowly? Finally, I had my key check on the state of the fundamentals in the housing market: rents. If the run-up in house prices reflected fundamental conditions of supply and demand, then there should have been a comparable run-up in rents. There wasn't. Rents rose somewhat more rapidly than the overall rate of inflation in the last 90s and the beginning of the current decade, but had nowhere near the run-up as home sale prices. More recently rents have trailed the rate of inflation. No economist has been able to give an explanation for how fundamentals could lead to a run-up in house sale prices, while having no noticeably effect on rents. Good reporting would have prominently noted the evidence that the run-up in house prices would not be sustained, that it was a bubble. In fairness, the media paid considerably more attention to the possibility of a bubble in the housing market than they did to the stock bubble in the late 1990s, which managed to almost completely escape the notice of economic reporters. Still, most of the reporting had the same cheerleading attitude to house prices that reporters routinely apply to stock prices. Unfortunately, when the cheering stops, it is the homeowners, not the reporters, who feel the pain.
--Dean Baker
