Not a buble

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sczech's picture
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Not a buble

According to the numbers quoted by Chris, house prices increased on average by a factor of 2. In comparison to the tulip mania (price increases by a factor of 30), this is a low multiple and for that reason, I think calling that price increase a "bubble" is an exaggeration. Exuberance is perhaps a more appropriate notion. I also doubt that house prices will return to the pre - bubble levels. Given the tremendous increase in the price of many commodities (copper. oil, wood), the increase in house prices is to a certain extent justified. After all, inflation is real. Inflation is not only a monetary phenomenon. With oil and other resources depleting, the purchasing power of money decreases steadily even if no new money is being printed.
Housing is an important capital stock in the US economy. Since our manufacturing sector shrinks steadily, the only source of income for our banks are mortgages, that is, loans backed up by houses. Houses are the only remaining sourse of capital in the US. For that reason, a crash in the housing markets can not be allowed.

GB904150's picture
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looks like a bubble to me
sczech - I don't think the multiple increase is important. Surely the multiple achieved all depends on the starting value.

Houses are the single largest, most highly geared investment that people make in their lifetimes. Prices are starting from a base of say $100,000, not $1 or so as in the Tulip example. This is why penny stocks can 10-bag whereas blue-chip companies would find it much harder.

An increase of 30-fold from say $1 to $30 means nothing in isolation - what is important is how affordable the asset is (price:income).

The cost of raw materials for housing may have increased somewhat (add 10-20% onto build costs), but this in no way can explain a 2-fold rise. Also, productivity should have improved and labour costs fallen over this time, negating some of the raw material costs.

The argument that housing 'is important' is precisely the problem. With the move away from manufacturing toward a service economy the only way of increasing GDP is by inflating asset prices (thus increasing debt). This is what Chris shows with the increase from $21trn to $48trn in debt over 7 years!

The problem with this is unsustainability. The Fed has blown these bubbles (by way of low real interest rates) to cushion us from economic shocks, but all this has done is delay (and increase) the eventual pain when the bubble bursts.

It is now no longer a question of whether a housing crash 'can be allowed', it is happening right now. The only relevant point is whether we allow a painful and long overdue correction to happen naturally as it should, or try to intervene and prop up the market which will cause wide-scale monetary problems over a much longer period, as Von Mises mentioned.

Great chapter Chris. Keep up the good work.
DanS's picture
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Apples vs. Oranges
I appreciate Chris's explanation of 'bubble' psychology, but the chart showing U.S. inflation as a flat horizontal line relative to real estate appreciation is economically misleading. Home price appreciation should be compared with the loss in value of the currency--i.e. 'inflated dollars'. His following chart which shows real estate values vs. income support is more informative, in my opinion. Consequently, sczech makes a valid point. Single-family residences ("SFR" serves a fundamental human need...shelter) and thus serve as a vital physical commodity. Commodities are a good investment when a currency is being debauched. Yes, prices will substantially decline for the NEAR TERM. Those who get really burned here are RE flippers and those who looked to get rich quick--i.e. no-down RE nonsense. Those who made purchases for the long term will survive. As the Fed and Treasury bail out Freddie and Fannie, new money will be created and infused which will result in shoring up real estate values. All political parties are committed to having SFRs, and the industry that creates them, remain American's core investment and major manufacturing sector, respectively. The Fed, Treasury, and politicians with their heads screwed on straight are starring at a potential "debt deflation." Read Ambrose Evans-Pritchard's most recent gaze into his economic crystal ball--Monetarists warn of crunch across Atlantic economies at:
davefairtex's picture
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Joined: Sep 3 2008
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a bubble by any other name

It may be that the banks do not want a housing crash, yet if banks lend prudently going forward, housing prices must drop to the level where they are affordable. People can't buy if the banks won't lend. So as a result, the median home price must be affordable to a household with the median salary.

In CA in 2007, the median "homeowner" income was $71,850. That yields an expected median house price of $269,565 using conservative (historical) lending criteria of 3x salary + 20% down. The median house in CA was $301,000 as of Aug 2008. That says we're approaching the level of basic affordability, but we are not there yet - another 10% down left to go.

The fun part is, though, when the declines are over, all the people buying after 2002 will be underwater, and the numbers are even worse that that, considering the home equity "live richly" loans taken out during that period. Underwater homeowners mean short sales and/or walkaways when circumstances force a sale (death, divorce, job loss, etc). And remember, this is happening just when the boomers are starting to retire - selling the big house and moving to a smaller one.

So while we're approaching an affordable median price here, the huge number of people underwater coupled with the massive overhang of defaulted property, during a recession and a 20% stock market decline, will continue to drive property prices lower than the affordability levels would indicate.

Perhaps because of this, major price moves tend to overshoot fundamentals pretty dramatically, and this is the worst real estate crash in 70 years, so my opinion is, if monetary inflation stays normal we'll blow through the basic affordability levels pretty dramatically, and the recovery (as happened in Japan after their real estate crash) will take perhaps 10-20 years. I don't think we are going back to 2005 "party time prices" any time soon.

Perhaps you're suggesting the banks will support massive monetary inflation to support nominal housing prices? It could happen. But as soon as it does and inflation expectations become "unanchored"*, the dollar gets crushed, our national debt becomes much more difficult to service, and all the basic commodity prices spike including oil. And all those foreigners holding our bonds lose a bunch of money. Probably the dollar is no longer a reserve currency.

After our most recent bailout the buck is already starting to fall, and oil is once again rising, on no material "oil" supply/demand news.

But its an interesting idea. They might do it. Its certainly a high risk strategy though, and possible political suicide for whomever is in office at the time.

blackrott's picture
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Personally I think the
Personally I think the housing market will fall much more perhaps another 50%. We are told that there is an 11 month supply of home on the market. "Fuzzy Numbers" This is just MLS info. Add the previous suppy before the Morgage crisis, add REO's, add FISBO's (fore sale by owner), add any other shadow market. In the heavy hit areas we have a 4.5 year supply. you can also add in all the vacant houses people abandon months before the foreclosure. Add the foreclosure legalities and months (in some cases 9 months)before it becomes bank owned. Before it can even be listed. This next year is going to be bigger than last year for the foreclosures. (surprized). add another 2 years of surplus. My guess is 5 years till we get to the bottom. Is it possible to have a 10-15 year supply of homes on the market. Huge Suplus, Difficulty Provinding Loans, no more 0 down or 80-10-10 loans, you will need 20-30% down. Factor in: energy crisis, credit crisis, baby boomer crisis with their life saving tied up in a house, dollar crisis, stock market crisis, the list goes on. Of this perfect storm how many problems have to collide at once for the system to fail? 1,2,3,4,5 If energy prices skyrocket, who will buy that big house? you will see a trend towards small housing. If confidence falls who will buy? If you can't get a loan who will buy a house? Do not buy, I suggest renting. You can rent twice the house for the cost of a morgage. A house can go negetive equity. It's the only investment you can go upside on. Hey don't fear there are plenty of empty houses so you won't be homeless. Wait this storm out. When the market hits bottom it will be there for a long time. It's possible they won't be able to give houses away. Get it out of your head that you have to own right now.
bobb dobbs's picture
bobb dobbs
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Joined: Apr 22 2008
Posts: 31
Question for blackrott
I agree with your analysis and advice. I hope my children read it and take it to heart. Would you expand on this statement: "It's the only investment you can go upside on."? I think it's NOT the only investment you can go upside on. Maybe I don't understand the meaning of "go upside". TIA for explaining.

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