Was There a Housing Bubble?

Alex Tabarrok has generated quite a buzz over his suggestion that the “housing bubble” might be a myth. He begins with this graph of housing prices from Robert Shiller published in the NYT:

Housing Bubble Graph

The clear implication of the chart is that normal prices are around an index value of 110, the value that reigned for nearly fifty years (circa 1950-1997). So if the massive run-up in house prices since 1997 was a bubble and if the bubble has now been popped we should see a massive drop in prices.

But what has actually happened? House prices have certainly stopped increasing and they have dropped but they have not dropped to anywhere near the historic average.

He goes further and posits that prices are unlikely to ever drop anywhere near the 110 level which means we’re not only not in a housing bubble but have established a much higher equilibrium.

Paul Krugman terms this analysis “strange,” noting that past bubbles took around six years to fully deflate and that the housing futures market is expecting a continued decline for the foreseeable future.

Megan McArdle agrees that there’s a new equilibrium but is baffled as to why it should be.

Fester figures the combination of cheap, easy credit and rampant speculation in the housing market constitutes a bubble no matter how you slice it.

Our own Dave Schuler, moonlighting at his own site, lists seven reasons why the whole thing is unlikely to “blow over” any time soon.

Kevin Drum finds Tabarrok’s argument “odd,” noting that “I too don’t expect to see home prices go down to their historical levels, but if the housing index goes from 110 to 200 and then crashes back to 160, what would you call that? I’d call it both a new equilibrium and a bubble.”

So would I.

At the individual level, it all depends on timing. If you bought a house in the Washington, D.C. area twenty years ago for $150,000 and can now sell it for $900,000 and retire to Florida in luxury, you’re in great shape. It really doesn’t matter that you’ve “lost” $200,000 compared to what you could have sold the same house for eighteen months ago. On the other hand, if you bought the house three years ago for $1.1 million and can’t keep up with the new rates now that your ARM has kicked into gear and can’t sell it and pay off the mortgage, the fact that the house still has historically high value isn’t of much consolation.

At the macro level, though, it’s hard to argue that it’s not a bubble. One can argue, as I have, that it was a self-fulfilling prophecy largely created by years of “housing bubble is coming” prophecy and a Fed trying to cure irrational exuberance by jacking up interest rates. But that doesn’t make it not a bubble, just a bubble that didn’t have to burst.

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James Joyner
About James Joyner
James Joyner is a Security Studies professor at Marine Corps University's Command and Staff College and a nonresident senior fellow at the Scowcroft Center for Strategy and Security at the Atlantic Council. He's a former Army officer and Desert Storm vet. Views expressed here are his own. Follow James on Twitter @DrJJoyner.

Comments

  1. yetanotherjohn says:
  2. fester says:

    James — I’m a little puzzled by your argument that “it was a self-fulfilling prophecy largely created by years of “housing bubble is coming” prophecy and a Fed trying to cure irrational exuberance by jacking up interest rates.”

    Try finding a prominent, non-Krugman, non-Dean Baker columnist who had an audience of at least 10,000 eyeballs a week in 2003/2004 saying that there was an imminent housing bubble. I don’t think you are going to find that individual. You’ll find a couple of bloggers who were saying ‘something funky is going on here’ in 2003/2004 but Calculated Risk, the biggest housing blogger today is still not widely read except for info and finance junkies.

    Maybe you forgot to type ‘bursting’ of the bubble in your argument, but the bubble was co-occurring with generationally low interest rates and massive amounts of media cheerleading, and every idiot can be a multi-millionaire house flipper seminar selling a ‘new paradigm’ of ‘housing only goes up’

    The supply of greater fools ran out and that is what caused the bubble to burst.

  3. James Joyner says:

    Maybe you forgot to type ‘bursting’ of the bubble in your argument, but the bubble was co-occurring with generationally low interest rates and massive amounts of media cheerleading

    True enough. Still, it’s only a “bubble” if it bursts; otherwise, it’s merely “growth.” Look at some of the “Related Articles” above — there were WaPo and NYT gloom and doom stories two or three years ago on this.

    UPDATE: OTB’s first Housing Bubble post was in April 2004.

  4. carl says:

    Take it from us here in south florida. This bubble will certainly burst!

  5. fester says:

    James — once again you prove you are an adept, insightful analyst of trends 🙂

    You’re argument makes a bit more sense now that we are inserting ‘bursting’ into the sentence, but it is still a bit tautological — it is only a bubble if it bursts and not is parabolic growth rates typical of a mature asset category and are deviations of three, four and five standard deviations from previous trend relationships with otherwise reliable proxies explainable by anything other than ‘new paradigm’ talk?

  6. James Joyner says:

    is still a bit tautological — it is only a bubble if it bursts

    Until it bursts, it’s a speculative bubble. Just as two quarters of negative growth isn’t a recession until it is. Or, accumulated rain isn’t a flood until it reaches some depth or strong winds aren’t a hurricane until they reach a certain speed.

    Sometimes, unprecedented growth isn’t a sign of impending catastrophe. For example, a Dow basis of 1000 seemed wildly optimistic in 1980 and anything under 10,000 is now disaster.

  7. Abq says:

    When the home price is going up at much higher rate than building cost or real income, it is certainly a bubble. Government tried to stop the burst with historic low interest rate but that just fueled into the bubble. When you can fit all the people in whole world in Texas and still not get the density of NYC or many popular city and hear that we are running out of land, then it was actually a bubble. Asking price for a land in a good area has gone down 50% in just a year. That is in sunny low-crime San Diego neighborhood with great schools. Reports from Florida would be the same. Unrealistic expectations and biased information created the bubble. Unfortunately newspapers were a part of it. And it is funny now they claim its all bloggers fault. The propaganda machine of NAR, brokers, main-stream media, every other home-owner, TV programs like “Flip this house”.. could not stop couple of bloggers.. Thats funny.