Blowing Bubbles
The best assessment of the housing price bubble in a long time comes from Morgan Stanley. This addresses both the housing bubble in the United States and in the rest of the world. Steven Roach addresses the why's of the housing bubble:
Morgan Stanley: Global: Global Property Bubble?
If price inflation in the real economy is unusually constrained by structural factors — precisely the case today — then the impacts of the liquidity cycle may simply spill over into asset markets. The equity bubble of the late 1990s was but the first example of this phenomenon. After it popped, excess liquidity then flowed into bond and property markets. As seen in this context, asset bubbles are a perfectly logical consequence of a more generalized monetarist model — one that sees the money supply driving some combination of prices in the real economy and prices in asset markets. When pressures bear down on one segment of this broader price structure — precisely the case in this no-pricing-leverage era — then the impacts of liquidity creation simply should show up elsewhere. It's just like pushing on a water balloon — inflationary pressures migrate elsewhere in the system to the point of least resistance. In today's post-equity-bubble world, that "elsewhere" is the property market.
To the extent that view is correct, then a turn in the liquidity cycle could have ominous implications for asset markets — especially overextended property markets. And that, of course, is exactly the risk as the world's major central banks now begin to implement "exit strategies" from the extraordinary monetary accommodation that is currently in place. This is likely to be a very delicate operation, to say the least. Housing markets that have gone the furthest to excess are, of course, most vulnerable to a back-up in interest rates. That's especially the case in economies where housing, according to our tabulation, is now in bubble territory — namely, Australia, the United Kingdom, China, Korea, Spain, the Netherlands, and South Africa. Nor can risks be taken lightly in those economies that we have put on the "bubble watch list" — namely, the United States, Canada, France, Sweden, Italy, Hong Kong, Thailand, Russia, and Argentina.[emphasis added]
Dick Berner deals with the U.S. market specifically:
US home prices rose 7.7% nationwide in the year ended in the first quarter of 2004, but local and regional price changes are becoming more dispersed, pointing to deceleration or declines in what were the most frothy markets or in those with the weakest economic fundamentals. In my view, a few markets (maybe 15 metropolitan areas) are still at risk for declines of around 10-15% as interest rates go up; however, these areas are in most cases where prices have nearly doubled in the past 5 years.
For the first quarter of 2004, home prices declined in six states — Vermont, Alaska, North Dakota, South Dakota, Iowa, and Nebraska; this represents an increase from the fourth quarter of 2003, when no states reported declining home prices. In early 2004, prices declined in thirty-nine of the 220 ranked Metropolitan Statistical Areas (MSAs), compared with only three in the fourth quarter of last year.
Prices rose the most over the past year in the Pacific division — up 12.2% — which is comprised of California, Oregon, Washington, Hawaii, and Alaska. Bubble sleuths should look there for potential trouble. Home prices rose least in the West South Central division — up 3.2% — which is comprised of Arkansas, Louisiana, Texas, and Oklahoma. Most MSAs in California and Florida continue to dominate the Top 20 when ranked using annual price changes.
Home sales and housing activity have yet to be affected by rising interest rates; in fact, home sales surged in May as fence-sitters jumped to buy before rates rose further. We fully expect sales, starts, and prices to cool significantly by year-end.
I think he's missing one big area — the Northeast Corridor, from Washington, DC up through New York, NY, to Boston, MA. These areas have seen doubling or more of prices in the past five years. Roach mentions the prices of apartments in Manhattan as an example of why the U.S. housing market might indeed be considered a bubble. I don't have good figures on this, so bear with me, but I wonder how the U.S. market would look if you looked at it weighted by market capitalization. In this case, the markets that are troublesome, the Northeast Corridor, the Pacific Coast, have both a huge percentage of our population and a very large share of our housing capital stock. If these collapse, the effect on the economy will be disproportionate to their acreage, and will affect a great number of people.
If the increase of inflation causes the Federal Reserve to increase interest rates, this will constrain consumer demand. This will push the U.S. economy back toward recession, or at least little to no growth, and the combination of little growth and increased interest rates make houses unsellable at the prices people have paid for them. A similar thing happened in Houston, TX, back in the early to mid-1980's when all of a sudden the oil prices collapsed. People couldn't give their houses away for what they had paid, and so the banks ended up with a bunch of houses and no liquidity.
Why does all of this concern me? I'm fortunate enough to live in and own a dinky little townhouse here in the DC area. Or, as Mrs. Datanerd likes to call it, a quarter-million dollar home. It's preposterous, but there you go. If I was being a rational economist, I would have sold it already, and moved back into the apartment we moved out of to move here. The price of that apartment has gone down in the past 4 years.