CalculatedRisk previewed the latest UCLA Anderson Forecast and Dr. Leamer is concerned that residential investment demand will decline – especially in California. Lawrence Kudlow suggests that Leamer and CalculatedRisk are “bubbleheads”. Kudlow gives a couple of interesting reasons for questioning forecasts of weak residential investment, but he also provides the following strange logic:
Although year-to-date housing starts have kicked up to 2 million, average new construction since the early 1970s has hovered around 1.5 million to 1.75 million new starts per year. During the same period, the number of American households has increased by 48 million, or 75 percent, according to the U.S. Census Bureau. It is plain to see that the family demand for homes has far outstripped the supply of newly built residences. So it should not be shocking that home prices have tended to rise on a steady basis, averaging 6.5 percent price gains over the last 35 years.
I’ll take Kudlow’s word for his assertion that the nominal price of houses is now nine times what we observed 35 years ago but since the general price-level in 2004 was 4.14 times what it was in 1969, this nominal appreciation amounts to a relative price increase over the past 35 years than less than 120%. CalculatedRisk has provided lots of informative graphs and discussions on the real estate market with this one of particular interest. The relative price of housing in California at least has risen substantially over the past few years but all that can be said about the 1976 to 1998 era was that real housing prices were volatile. Kudlow, however, seems to be confused over the difference between flows of residential investment versus stocks of houses. The following graph shows residential investment as a share of GDP and does indicate that the current investment to GDP ratio is not extraordinarily high even if it is above what we had seen in recent years. The graph also shows residential investment demand is volatile. But Kudlow’s observation that they are 75% more households today as compared to 35 years ago does not mean that the house to population ratio has necessarily declined for a simple reason – housing once built tend to last a long time. President Bush was telling some Maryland audience today why we needed to have more pork barrel spending for the energy companies paid for by more tax cuts (ah let our kids pick up those massive deferred tax liabilities) and gave his usual sunny stump speech, which included reminds me of Kash’s post Bush Takes Credit for Home Ownership. If demand is outstripping supply as Kudlow suggests, then why has the ratio of houses owned to population increased? I have not done the math necessarily to convert the average residential investment demand to GDP ratio into an annual percentage increase in the housing stock, but let’s suppose the housing stock has grown by about 2% per year for 35 years. If there are 75% more households but twice the number of houses, then Kudlow’s numbers are not contrary to what Bush said after all.
Kudlow also notes that mortgage rates are still modest. Bush’s insistence on continued long-term fiscal stimulus is certainly not the reason. I would argue that the continued weakness in labor markets is part of the explanation even as Bush claims employment rose by 3.5 million during his first term (I guess no one ever told him about the BLS footnote in the tables reporting the Household Survey figures). Kudlow seems to think that appropriately tight monetary policy is the reason why mortgage rates remain modest even though he had earlier criticized tight money even as he claimed the labor market was strong.
Kudlow also notes that the homebuilder stocks such as Toll Brothers have enjoyed significant price increases over the past few years as sales and profits have increased. Since stock valuations reflect expect expected future cash flows, these high valuations do seem at odds with the forecasts from Dr. Leamer. Perhaps, the premise that California’s real estate bubble is only regional and not national suggests to Wall Street investors that while those in LA might be wise to sell their house, the fortunes of companies that have economic activities across the nation may differ. While these stock valuations declined on Monday, their valuations remain quite high. However, Richard Suttmeier’s Homebuilders’ Charts Testing Hearts (RealMoney) suggests that they are overvalued. I have just one question for Mr. Kudlow: are you purchasing or selling shares of companies in this sector?
Update: Thanks to CalculatedRisk for pointing out that the Census Bureau provides historical data on the total housing inventory. All units in 1969 were 69.778 million and were 122.187 million in 2004, which represents a 75% increase.