Thursday, February 24, 2005
'Irrational exuberance' -- again
There is no hope of explaining home prices solely in terms of population, building costs or interest rates. None of these can explain the "rocket taking off" effect starting around 1998.
So what did cause this real estate boom in so many parts of the world? My conclusion: Home-price speculation is more entrenched on a national or international scale now than ever before.
What is so difficult about dealing with bubbles, from the point of view of a central banker, is that the symptoms are the same as what you would see with a healthy economy, at first. Who wants to step in and take the punch bowl away (a common metaphor describing wouldbe bubbleenders) when everyone is having such a good time. To this day, there are economists that do not believe that there was a stock market bubble in the late 1990's and that it was Greenspan being overly cautious with monetary policy that caused the Nasdaq to collapse.
The ascent in home prices since 1998 has been much faster than the rise in incomes, and this raises concerns about the long-run stability of home values. From 1985 to 2002, the median price of a home rose from 4.9 years of per capita income to 7.7 years in the eight most volatile U.S. states; thus in these states, which account for more than a quarter of the country's population, there are significant new stresses on family budgets in making mortgage payments.
What defines a bubble is significant price increases beyond income. I am sure you know people whose home price increases have far outstripped their income. The danger for our economy is that many of those people have used their home equity as a piggy bank to be broken open in times of hardship. (By the way, LCD displays are coming down in price. I saw a 30" LCD for $999) With household credit market debt increasing to over 300% of GDP in the past few years, I can imagine that someone is going to take away the punch bowl very soon.
MattO: NO! NO! This can't be another bubble! Why, just this past friday I heard the CEO of Century21 say that "it's different this time." Where/When have we heard that phrase before? Oh yes, March2000 on the NASDAQ!
As my co-bloggers know, I just sold my California property and am planning on moving back to Sweet Home Chicago. My friends in finance call this the "coastal swap"; sell property on the coast (either of them) and buy in the midwest- sell high beta, buy low beta. I am quite comfortable that I won't regret this move.
BillC: Matt, when you end up buying a place in Chicago I am curious to know how close you come to buying twice as much home for half the money. Also, I don't know what home prices were like in our old 'hood 10 or 15 years ago but I know that Chicago has seen a lot of price appreciation in that time. Anyway, you will still end up with a lot for your money.