Stephen Roach is apparently unconvinced by those who argue that there is no housing bubble. From today’s Financial Times (subscription required):
Five years after the bursting of the equity bubble, America has done it again. This time, it is the housing bubble. But this speculative excess may be the cruellest bubble of all – and has already led to a sharp compression of national saving, a record current account deficit and an ominous overhang of personal indebtedness. The US was fortunate in avoiding the perils of a post-bubble carnage in 2000-2001. It may not be so lucky this time.
The debate over a US housing bubble is now over. The recent US house prices report for the third quarter was a shocker – an 18.5 per cent annualised surge from the second quarter and a 13 per cent increase from year-earlier levels, according to the Office of Federal Housing Enterprise Oversight (OFHEO). That represents a stunning acceleration from the 9.8 per cent year-on-year increase of the second quarter, and pushes nationwide house price appreciation to a 25-year high.
Housing analysts and central bankers are typically reluctant to draw macro conclusions from a highly fragmented US property market. The risk is they focus on the trees and miss the forest. The latest OFHEO tally shows house price inflation has run at double-digit rates over the past year in 25 of 50 US states plus the District of Columbia. Housing is an asset class just as prone to excess as stocks, bonds, currencies and commodities. If it feels like a bubble and acts like a bubble, it probably is one.
I tend to agree with Roach — this seems like a bubble, so Occam’s Razor (i.e. common sense) suggests that it probably is one. The specific arguments in the paper I cited yesterday that argued that there is no bubble in house prices still bear some attention and further thought… but I still don’t believe that the sort of increases in house prices that we’ve seen over the past couple of years can be explained away by quality adjustments.
Instead, I think that the FRBNY paper is a classic example of Stage Three of Rudi Dornbush’s famous “Five Stages of Currency Overvaluations,” which Brad DeLong wrote about in a recent piece for Business World Online. Simply replace “currency overvaluation” with “house price overvaluation” and it seems quite applicable to housing markets in many countries today:
- First, short-term speculators seeking higher returns, or investors overanxious for safety, drive a currency’s value to unsustainable levels.
- Second, trend-chasers keep buying because the returns have been so good in the recent past, thus pushing the overvaluation to a height and duration that orthodox economists cannot explain.
- Third, highly intelligent economists, puzzled by the duration of the overvaluation, evolve theories of why things are different this time, and why this time the overvaluation is perhaps sustainable after all.
- Fourth, market bulls, encouraged by theories of a “new economy” that justify the extraordinarily good returns seen in the recent past, keep buying and keep the currency suspended above economic fundamentals even longer.
- Fifth, the supply of eager purchasers and trend-chasing investors comes to an end, producing a crash that resembles the collapse of a Ponzi scheme.