with Peter van Doren


U.S. house prices surged in 2020, rising 11.2 percent for major metropolitan areas according to the Case–Shiller Home Price Index and 12 percent according to the Federal Housing Finance Agency. This has raised concern that a new housing bubble has formed and is threatening a repeat of the “Great Recession” of early this century.

If “housing bubble” means that home prices rise in a relatively short time and then fall back to long-term trend, then a bubble likely has formed over the past year. But this bubble, by itself, would be different—and less ominous—than what happened early this century. That said, there is something troubling going on in the U.S. housing market and government should take steps to address it.

The sharp increase in U.S. house prices over the years 1998–2006 was driven by a rise in demand (or, speaking carefully, an outward shift in the demand curve) for homes in major coastal metropolitan areas and some other places, even as home construction reached high levels. Those areas were booming economically, attracting workers who bought or rented dwellings in the cities and their suburbs and exurbs. At the time, financial markets (and their regulators) considered instruments tied to mortgages to be (to borrow a Victorian idiom) “safe as houses,” encouraging them to finance all this homebuying. Small-time investors got in on the buying spree by purchasing second (and additional) houses, either to “flip” or rent out in the hot market.

When gasoline prices spiked in 2005–2008, long commutes from the suburbs and exurbs became costlier, bringing financial hardship to households and subsequent mortgage defaults. Mortgage-related investments soured, setting off a financial crisis. The crisis spread to the broader economy, which was already struggling with a business downcycle from the suddenly cooled housing market and its effects on related industries and household wealth, yielding the Great Recession.

This time around, there’s at least one important difference: the spike in home prices over the past year is to a large extent supply-driven. Because of the coronavirus pandemic, homeowners have become less inclined to put their houses on the market, and government-mandated forbearance has further reduced the availability of homes. As the Wall Street Journal reported in January, the number of houses for sale in November 2020 was 22 percent less than the year before. This decreased supply has disrupted the normal “churn” in housing markets as households grow in size and seek bigger homes and then shrink and seek smaller ones.

(We note there also is evidence of recent increased demand for housing in suburbs and exurbs as newly telecommuting workers flee population-dense areas because of the pandemic. We’ll see if this outmigration persists long-term and if it affects overall house prices or just increases suburban and exurban prices relative to urban ones.)

The supply constraint should ease as more Americans are vaccinated against the coronavirus and the nation approaches herd immunity. It’s likely that, once the pandemic fades, pent-up churn and delayed foreclosures will result in a flood of homes hitting the market, accompanied by a decline in house prices. The bubble of the last year should deflate without much hardship.

That said, things are not well in the U.S. housing market. The surge in prices over the last year is just the tip of a longer rise in house prices dating back to the end of the housing bust in 2012. Indeed, the increase can be traced all the way back to 1998, suggesting the 1998–2006 price increase wasn’t a bubble, but rather the 2006–2012 bust was the short-lived departure from trend.

Higher home prices hurt homebuyers (especially young professionals and new families), both because of higher mortgages (though low interest rates in recent years have kept monthly payments lower than they would have been otherwise) and by reducing the supply of homes that would better fit families’ particular needs. This needs to change.

The decline in long-term interest rates is one contributor to the higher house prices, as well as the prices of other assets. Another contributor—one that government can address—is its many anti-housing policies currently in place, from restrictive zoning and “smart growth” requirements, to tariffs on building materials that have sent lumber, metal, and home appliance prices soaring, to immigration restrictions that have reduced construction labor. Fortunately, government can undo those anti-housing policies without increasing public spending, taking on risk, or imposing more burdensome regulations. This would not only produce more housing units, but also increase the supply of existing housing for sale and put downward pressure on overall home prices.

Such reform shouldn’t cause a painful sudden collapse in house prices. The time involved in home construction—not to mention the interminable permitting and inspection process—would moderate the flow of new housing. Hopefully, there would be a gentle, long-term decline that would return house prices to their pre-1998 trend. But even if house prices would just plateau or slow their rise, that would give many American households a much-needed break.


Peter Van Doren and Thomas A. Firey are senior fellows at the Cato Institute and, respectively, editor and managing editor of Cato’s policy journal Regulation.