Alex Tabarrok adds to the debate:
The real question is not whether there is a bubble the question is, What are the chances that housing prices will fall dramatically? Contrary to popular belief, knowledge of whether prices are following fundamentals or a bubble tells us very little about this question. An efficient market is not necessarily a stable market. Indeed, an efficient market can be as or even more volatile than a market plagued by bubbles … Since r and g are small a small change in g can have a large effect on the P/E ratio – so much in fact that it is very difficult to reject a model of stock prices based solely on fundamentals
Let’s return to this after we follow-up on a small detail related to the update to yesterday’s post. AB reader Rich Berger rightfully insists on an apples-to-apples comparison as far as time periods and notes a 67% increase in the number of houses from the end of 1972 to the end of 2004. The Census also reports that total population increased by 41% over this same time period whereas Kudlow claimed a 75% increase in the number of households over some vague statement of what the time period was supposed to be. So while the number of housing units relative to the number of households may have roughly stayed the same – assuming Kudlow’s reporting is correct, it would appear that there are fewer people per household. Unless houses today are smaller than they were 30 years ago, there is more housing space per person.
Alex Tabarrok’s discussion related to Kudlow’s discussion in the following way. AB reader Movie Guy notes that the increase in the relative price of housing has occurred only recently. Alex is noting that the recent fall in interest rates would tend to push up the relative price of housing quite rapidly. Conversely, a rise in interest rates would tend to lower the price of housing quite rapidly, which would have a dramatic impact on the demand for residential construction – even if the “bubbleheads” are wrong about housing being currently overvalued.