Subprime Daily Briefing, Dec. 14
By Arnold Kling
Just a couple of remarks on housing market equilibrium.First, Paul Krugman.
To restore a historically normal ratio of housing prices to rents or incomes, average home prices would have to fall about 30 percent from their current levels.
…Markets won’t start functioning normally until investors are reasonably sure that they know where the bodies — I mean, the bad debts — are buried. And that probably won’t happen until house prices have finished falling and financial institutions have come clean about all their losses. All of this will probably take years.
The chart shows that the ratio of median house prices to median family incomes rose from 2.3 in the 1970’s to 3.0 in 1981, then dipped back to around 2.7 or 2.8 through 2001, from which point it rose to 4.0 at the recent peak. In the latest point in the chart, it is at 3.8.
Recall that I said that for a homebuyer, this ratio should be no higher than 6. The median ratio perhaps ought to be lower, because the bottom end of the income distribution should include a lot of people who are not home owners, and rental housing ought to have a lower price/rent ratio.
Anyway, I don’t think we should take 2.8 as some absolutely correct ratio of median home prices to median income. It’s hard to know the right number. I don’t recall thinking that the housing market was out of balance in 2003 or 2004, when the ratio was at 3.25 or so. My guess is that if you were to get everybody who has a house price more than 6 times income out of their houses, we would be back in balance today. I don’t think that requires a 30 percent drop in home prices overall–just in a few spots where people went nuts.
My guess is that the near-term loan losses are going to be larger than people are expecting, because of fraud. But the longer-term scenario might not be so dire, because I don’t think balance in the housing market is as far away as the doomsayers believe. Keep in mind that the Paul Krugmans and Steve Roaches of the world are always on the pessimistic side, and I tend to err in the other direction.