Housing Bubble ?
Robert Waldmann
Andrew Harless argues that there was no housing bubble ?!?
Apparently it is now generally accepted that the rise in house prices was an aberrant bubble, justified only in the minds of irrational buyers who ignored the fundamentals and expected house prices to keep rising simply because they were already rising.
But what were the fundamentals? Certainly, if one had foreseen today’s circumstances, it would have been clear that housing was not a good investment. If one had been able to say, “In a few years, the unemployment rate will rise to 10%
Go read the whole post. I can’t choose the key quote but basically he argues that high asset prices were required to achieve a normal unemployment rate and therefore they weren’t aberrant. He argues that it must be possible to achieve normal unemployment without a bubble. He then sure seems to argue that since some asset price could have been sustainably high, clearly US houses were those assets.
More after the jump
This time I’m not convinced. You don’t define bubble and don’t respond to the alleged evidence that there was a housing bubble. Why was the relative price of housing in the 21st century so much higher than in the 20th (during which it was quite stable) ? Why was the ratio of price to rent so high ? Neither is easy to explain assuming 4% unemployment.
In effect you claim that, if policy makers agressively countered the recession and we were at full employment now then housing would have been a fine investment. So why did everyone with a brain and an open mind assert back in 2006 that there was a housing bubble (that is housing was a very bad long term investment) ?
I think an important issue is that you note a worldwide problem and assume that the US economy can solve it.
If you were writing about the alleged housing bubble in Ireland (I am sure there was such a bubble I only use “alleged” in an attempt to be polite) such a claim would sound silly. I think it is also silly for the USA. The US can’t keep running huge current account deficits forever. The global savings glut requires increased final demand in other countries
Two incomes, rents being pushed up by low vacancies, but the major price pushers were lower interest rates (mortgage rates have been falling since 1984, from 15% to 10% to 8% to under 6%) and, also, effective interest rates of the teaser/negative-am loans.
Negative am was the big wrinkle in the previous boom, it created immense buying power, and whenever you give the buy-side buying power, prices will go UP!
The top researcher in the field (Robert Shiller) claimed that he knew there was a bubble before it burst. I think he made an absolutely rock solid proof beyond reasonable doubt case back then. Harless disagreed. I just discovered Harless (I am a major fan) so I don’t know what he argued back then, but I don’t see how he could have countered the evidence presented by Shiller before the bubble burst.
I’m not an expert. My guess is that house prices couldn’t level off. If I understand correctly many people took out mortgages that they could only service if house prices increased rapidly (allowing them to service their subprime option arm balloon loan with a home equily loan). Flat prices imply defaults, foreclosures and a collapse of prices.
Even without that mechanism, people were willing to pay huge prices because they predicted further price increases. The amount people are willing to pay under the assumption that house prices grow about like other prices is pretty much the amount they are willing to pay now or were willing to pay in 2000. It is much lower than the amount they were willing to pay in 2006.
One definition of a bubble is a price increase such that prices must drop sharply in the future. It is a key part of the definition that stable high but not rising prices are impossible. With the benefit of hindsight but the disadvantage of relative ignorance, I guess that in 2007, 2008 and 2009 house prices could have kept rising or could crash but couldn’t just stay where they were.
Real estate may or may not have been a “bubble”, but it WAS 70’s style inflation. The CPI never reflected it because the government underweights real-estate and it’s leveraged nature. The fed should have raised rates long ago to combat that inflation.
No it wasn’t. Wages didn’t go up so it wasn’t a wage-price spiral. It was a loan-price spiral, the loan being NINJA, negative-am, SISA, and of course outright broker fraud (straw buyer).
I didn’t catch on to the bubble dynamic — i thought 10-20% retrenchment was possible, but that’s all — until the Casey Serin story broke.
He was the first cockroach that indicated there was a serious underwriting problem. If a little snot like him could get $2M+ in loans, anybody could. And did.
I do not see why inflation has to be restricted to wage induced only.
troy-
wall street would not have touched it absent the GSE guarrantees on the mortages, or if they did, would have priced and rated the MBS’s totally differently. absent AAA ratings, few would have bought them. this was repuatational arbirtrage by the GSE’s. absent their guarrantees, this market would have been stillborn. look at the ned result – most everyone else has recovered and most of the big securitizers have already repaid TARP. but the GSE’s are a basket case and continue to sink. these are the guarrantees they used to create this market comeing home to roost. i think it is you who misunderstand what happened. it’s certainly popular to pillory wall st, but they were responding rationally to perverse incentives. they were the messenger, not the creator of the bad news.
orlando-
read the CRA. it mandated loans to subprime borrowers, particularly minorities, at rates below market. banks (like citibank) that tried to avoid participating were sued and forced to comply. this led to roughly $1 trillion in loans at highly subsidized rates. the banks knew they were terriblr risks, so they pitched them to freddy and fannie and got them securitized. no one wanted that stuff on their sheets.
troy-
also if underpricing mortages to the point where you are 40-90% of the market and skimming all the “vanilla” business off using goverment guarrantees to get a lower cost of capital than anyone else did not drive the market up, then i’d love to hear what you think it takes to do so.
troy-
here’s a quick primer:
http://www.businessinsider.com/the-cra-debate-a-users-guide-2009-6
also note that CRA drove big demand for subrpime MBS’s as buying them could count toward compliance for a lender.
Without wage inflation there cannot be general inflation, just reallocation. Eg. energy, food, taxes, health goes up, housing WILL go down, if wages are constant.
tyger, the AAA ratings came from S&P and Fitch on CDOs that were the big innovation funding mortgages. As for your CRA crap, if you believe that I cannot help you here.
“Why was the relative price of housing in the 21st century so much higher than in the 20th (during which it was quite stable) ? Why was the ratio of price to rent so high ? Neither is easy to explain assuming 4% unemployment.”
The price-rent ratio is very easy to explain. In fact, if you read between the lines, it was the whole substance of my post. Low unemployment required high asset prices. High asset prices required a low discount rate for future expected returns on assets. We saw this this in the dramatic decline in TIPS yields in 2002. We also saw it in a rising price-rent ratio. Maybe stocks were undervalued by this reasoning. But the high-employment equilibrium should have involved high price-return ratios for all assets. Anyone who was anticipating that equilibrium should not have considered a high price-rent ratio to be unreasonable.
As to the relative price of housing, that was a consequence of the high price-rent ratio. During the 20th centruy, we never saw a non-deflationary savings glut, so there was never a reason for house prices to be high. The closest thing we had was the late 1970’s, during which nominal house prices were rising rapidly, but since house prices are particularly sticky, they barely kept up with the aggregate price level.
You might argue, based on the lack of precedent, or on some sort of Austrian theory, that a persistent non-deflationary savings glut is impossible. I’m not sure how well I can counter that argument, but for now I still hold with the mainstream Hicks-Keynesian view on that point. It seems to me, if you want to argue that high price-return ratios have been inappropriate during this century, you have to reject the mainstream Hicksian model. You probably have to reject the classical model, too, in which a strong preference for future consumption (i.e. a high savings rate) would still be reflected in a low discount rate for future returns.
If you accept the idea of a low discount rate, then the problem was not so much a bubble in housing as an “inverse bubble” in stocks.
“…you note a worldwide problem and assume that the US economy can solve it.
If you were writing about the…housing bubble in Ireland…such a claim would sound silly.”
Not at all. There was a worldwide asset boom, but in some places asset prices were depressed. The US and Ireland were not among those places (at least with respect to housing). I took the US because it’s the most obvious example, but the fact that there were housing booms elsewhere (as there were also in many places besides Ireland and the US — and in some places there still are) supports my point. Why would bubbles just spring up randomly all at the same time in a bunch of unrelated housing markets?
“Why would bubbles just spring up randomly all at the same time in a bunch of unrelated housing markets?”
Banks perhaps?
Thank you for the reply–your observations are most intriguing and prompted me to do a little more research. I’m not yet convinced by data/theory that the boom necessarily had to either continue or bust, rather than lead to a period of stagnation.
Nationally, home prices rose far faster than inflation in the 1970s, but this was not a bubble (by definition) because it didn’t burst. Instead, growth barely beat the inflation rate during the 1980s, which was the worst decade for home price growth since WW II. See data at http://www.census.gov/hhes/www/housing/census/historic/values.html
An FDIC study at a regional level of 1978-1998 showed that “booms” are followed by “busts” about 40 percent the the time–more typical at the regional level is boom followed by stagnation (http://www.census.gov/hhes/www/housing/census/historic/values.html)
Robert:
You have a nice thread here. Just a few points and I will retire from the field.
There was no low unemployment since the end of the 2001 recession. The numbers of people joining the Civilian Labor Force from the Civilian NonInstitutional Population was on a downward trend as evidenced by a falling Participation Rate since then. The low U3 numbers resulted from the calculation and not the reality.
Remembering back when, when Greenspan signaled to the global economy he ws not going to raise Fed Rates and continued to keep them low. Remember too, people were now able to withdraw up to $500,000 tax free in equity from their homes after a couple of years. Two feeds to Wall Street with too few places to invest such as Treasury Bills. The next safe place to invest was Mortgages in a country relatively safe from down turns in land and prices. Domestic and Global money available as fuel to feed the economy.
The CRA had been around for years by now with no apparent ill effects from providing mortgages to minority and low income. In the beginning there was rational lending. The problem being the market was tapped for safe lows and the irrational exuberance of the market found a way to lend the over abundance of money out by becoming more and more creative in mortage loans. ~80% of the substandard loans were outside of the CRA.
Bundling and trancheing MBS into CDO and securing a AAA rating by insuring them with CDS, just extended the run in mortgage investing by Wall Street until the FED raised interest rates and many home mortgage people found they could not flip those ninja mortgages due to higher rates and their rates went up. “Tilt” game over.The collapse was on as people were foreclosed on and abandoned homes. Those MBS CDO were no longer a safe investment and the run on CDS. GS played the market well and taxpayers found they were supporting a Wall Street that was gambling on the come.
Somewhere I am sure Greenspan is knocking down some Booker’s bourbon and having a good laugh at our expense.
that’s a pretty feeble answer troy. and why do you thing S+P etc gave them AAA ratings? it was because ot the guarrantees. absent that, it would not have happened. why is it, do you think, that so many of these mortgaes and MBS’s wound up on freddy and fannie’s balance sheets?
i don’t think you understand this market at all. why, if not to get a better rating, were so many mortages pushed through F+F before being securitized? that costs money to do, so what was the impetus if not taking advanatage of the implicit government guarrantee?
i find that responses like “if you beleive that i cannot help you” generally really mean, “i am incapable of providing a factual answer”, so please forgive me if i fail to take you seriously there.
Nah!
The Ministry of Truth has been working on the forensic analysis, and is finding the story to be thus:
A very large number of unscrupulous borrowers all around the world decided to take advantage of the kindness of bankers and their supportive central banks. These greedy bloodsuckers decided to borrow massive amounts of money and spend it on houses of all things. (we all know they are supposed to start their own biz with it and hire people for minimum wage, but it’s a free country, weep weep)
To justify to their spouses the ridiculous prices they decided to pay, they constructed excel spreadsheets with flawed models indicating that the investment would yield a SUV, new furniture, and a second honeymoon in Hawaii over the next few years.
When one spouse asked the other who is going to get the job to pay the mortgage, one replied “You are!” and the other one shot back “No you!!!!”.
This argument was never resolved and the sneaky bastards went and got the loan anyway!
You can imagine how damaging personal behavior like this was to the banking system and the general economy.
The government has passed financial reform so this outrage can never happen again.