Housing Bubble: Who Knew?

So was there a bubble in 2003? Hard to say isn’t it– because housing prices haven’t declined to below 2003 levels. Only with the benefit of hindsight can we know there was a bubble instead of a fundamental changes that caused people to place a greater value on housing.

People talking about a bubble is not the same thing as “knowing” there is a buuble (as implied by the title of your post). Just as with the stories about pre-9/11 warnings of a terrorist attack, there are always those issuing warnings of one sort or another. The hard part is knowing when such warnings should be heeded and when they should be ignored.

This year, 2008, has been an interesting time to consider what it means to own a home. The US government has long favored homeowners while at the same time promoting debt (mortgage interest deductions, equity-lines-of-credit interest deductions, virtual elimination of capital gains taxes, etc) which has elevated the status of homeownership and, ironically, made homes too costly for many. As the government encouraged the rise in prices (now called a “bubble”) – a condition which is currently unwinding – homes came to be viewed more as investments than as sanctuaries. This led to the acquisition of debt beyond the ability of the borrower to pay, a situation where the home owns you rather than the reverse.

I believe that we are starting to see that when the government promotes one sector – like home building and ownership – and then tries to save all sectors from the resulting damage, we all pay a high price.

spencer, Newton also believed in alchemy and other occult nonsense. You can find tons of examples of smart people who fail miserably when they attempt something out of their narrow area of expertise. It is the rule rather than the exception. What is your point, that nobody can see a bubble forming? Many people could see that there was no reason for home prices to double in such a short period and that the rise was driven by the steady stream of cheap credit that allowed people to bid prices up so high, with the possible exception of the writer of this blog post, Arnold. Arnold did spot the tech bubble, however, as did many others, because it made no sense that those insane valuations would ever come true. It is always the excuse of idiots who invest in these bubbles that “nobody saw it coming,” when the evidence always contradicts that lie in a painfully obvious way. Anyway, I don’t see where you’re leading; if nobody can spot a bubble, therefore what?

Who knew?

I knew. I started developing an interest in economics specifically due to the budding bubble in housing in Silicon Valley, all the way back in 2004. The Bay area economy was still reeling from the aftermath of the tech bust. My search lead me to austrian theory of business cycle.

In May 2006 the CME launched housing futures and options contracts that use the S&P/Case-Shiller Index. Since the second week of the launch, the futures consistently pointed lower for one year out (the maximum duration at the time). There was a trading venue that unsentimentally traded down the forecast of housing prices.

In the second edition of his Irrational Exuberance book, Robert Shiller argues that the housing bubble began in 1998. Of course at that time it was way overshadowed by the then vigorously ongoing high tech stock market bubble, and it was only the end of that bubble that really provided the juice for the housing bubble.

Historically, although there have been scattered local housing bubbles, such as in Boston and LA in the late 1980s, housing has generally been a commodity not all that subject to speculative bubbles, although vacant land and commercial real estate have been. Usually people are more level-headed about their own homes. The only period of housing prices rising as fast as they did in 1998-2005 in the US was 1945-50, when it was clearly a matter of fundamentals, surging demand against a housing supply unchanged essentially since 1930. There was nothing like this going on after 1998, and the price to rent and price to income ratios were already at all time historic highs by 2003. It was just plain obvious that it was a bubble to anybody who looked at all closely.