Economists Capitulate to Housing Bubble

It's unlikely, given the high barriers to entry, in the housing market that you'll see widespread consumer capitulation to the housing bubble.  There will always be renters no matter how appealing houses look as an investment.  Still, it says something when trained economists buy into the idea that "What goes up can't go down"  Peter Coy, at Business Week, looks at one study in his piece Housing Markets Are Stable ... Until They're Not:

Three top economists made a splash on the Wall Street Journal's editorial page this past Monday with a piece headlined "Bubble Trouble? Not Likely."

But the way I read the research underlying the Journal piece, a better title would have been "Housing Markets Are Stable ... Until They're Not."

To show that there are no regional housing bubbles--and thus no reason for prices to fall--the economists in effect assume their own conclusion. They assume, without strong evidence, that buyers in each market will continue to expect the same kind of price gains that they've averaged over the past 60 years. If you expect prices to keep rising rapidly, you'll be willing to pay a whole lot today. The market will be stable.

But what if buyers in, say, San Francisco suddenly turn pessimistic about the rate of future price increases? That certainly isn't out of the question given how high prices are relative to rents, or incomes, or to prices elsewhere in the country. If they lose faith that the market will climb steeply ad infinitum, then their willingness to pay a huge sum of money now will plummet. And the market will tank.

Sounds right.  Who could disagree that people will be hesitant to devote $1 Million in future earnings towards their home if they get the idea that that value will diminish over time? 

I spoke with Todd Sinai of the University of Pennsylvania's Wharton School. He was co-author on the paper with Charles Himmelberg, a research economist at the Federal Reserve Bank of New York, and Christopher Mayer of the Columbia Business School.

Sinai defended the paper. He said it's reasonable to assume that if house prices in, say, San Francisco have risen at an after-inflation clip of better than 3% a year for the past 60 years, that people will continue to expect them to keep going up at that rate for the foreseeable future. Why? Because, he says, hot cities like San Francisco are pretty much built-up, so people are competing to live there by outbidding each other for housing. That, says Sinai, can continue as long as there are rich people in other parts of the country who would really rather live in San Francisco.

Sinai's defense uses Ponzi-scheme logic--that housing will always go up simply because it has, and there will always be people who want housing.  That economists have given into this thinking is a strong contrarian indicator...though with growing housing inventories, and rising interest rates it seems we should be past the contrarian indicator part of the cycle.

Comments

[Tom]

I'm a REI and the talk of the RE bubble is something that I concern myself with. All things go in cycles so what goes up must come down and then go up again. It this very reason that I cautiously buy at the right price.

You do have to remember that you make your money when you buy a house. If you buy at the market rate and then the bubble pops then you're SOL. If you buy at a discount then you have the ability to absorb a correction.

The next question you'll ask is "where are the discounts?" They're out there but they're not pretty.

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