Robert Shiller tells a bubble story.

Real rent has been extremely stable when compared with price. Real rent increased only 4 % from the 1996-IV to 2006-I. The rent figures indicate that there has been virtually no change in the market for housing services, only in the capitalization value of these services into price.

…our expectations data show remarkable confirmation of an essential element of the bubble story: times and places with high home price increases show high expectations of future home price increases.

I would tell a different story. I think that the rise in home prices reflects:

1. The decline in the inflation premium in interest rates. When nominal interest rates are high, payments on mortgages are high, making it hard to buy homes.

2. A general decline in real interest rates. For a long time, real interest rates were high, as realized inflation was low relative to the expectations that were built into nominal rates. Finally, over the past ten years, real rates have come down.

3. A decline in the risk premium for housing. The secondary mortgage market has become more efficient. Moreover, with the use of credit scoring in mortgage underwriting, credit decisions became more accurate (I consider this my personal contribution to social welfare–I pushed very hard for this innovation when I was at Freddie Mac).

4. Transaction costs have fallen. With the use of credit scoring, property valuation databases, and other innovations, the cost of obtaining a mortgage or refinancing a mortgage has fallen sharply. This in turn makes housing a more liquid asset, which lowers the risk premium involved in buying a home.

Having said all that, I can believe that some of the increase in prices over the past several years was over the top. Buyers’ expectations probably did get out of hand. But I think that the “irrational exuberance” was more on the lender side than the buyer side. That is, I think that the risk premium got too low, for a variety of reasons, perhaps including excessive confidence in credit scoring.

But my guess is that eventually the home price rise from, say, 1995 to 2007 will turn out to be 90 percent due to a permanently lower risk premium and 10 percent bubble, rather than the other way around.

Thanks to ‘Calculated Risk’ for the link to the Shiller paper, as well as other papers from the recent Jackson Hole symposium.

My guess is that the symposium created an exaggerated sense of the significance of the subprime kerfluffle. Too many finance/economist types with too little else to talk about.