August 22, 2005
Housebreaker
Still think we’re not floating along in the biggest housing bubble in history? Yale economist Robert Shiller has a chart he’d like you to take a look at:
Most analyses of U.S. house prices span 25-30 years of data at best. Shiller took a much longer-term approach: using old classified advertisements he was able to trace prices back to the 19th century. What he found was a consistent pattern of bubble and bust:
Every housing boom of the last few centuries has been followed by decades in which home values fell relative to inflation. Over the long term, the portion of income that families spend on their shelter stays about the same.
Builders become more efficient, as they are doing today. Places that were once sleepy hinterlands, like the counties south of San Francisco or a patch of desert in southern Nevada, turn into bustling centers that take pressure off prices elsewhere. Even now, the United States remains a mostly empty nation.
“This is the biggest boom we’ve ever had,” said Mr. Shiller, who bought into the boom himself in 2002, with a vacation home near one of Connecticut’s Thimble Islands. “So a very plausible scenario is that home-price increases continue for a couple more years, and then we might have a recession and they continue down into negative territory and languish for a decade.
“It doesn’t even attract that much attention,” he continued. “There will be many people thinking it was a soft landing even though prices may have gone down in real terms by 40 percent.”
Shiller’s analysis isn’t wholly pessimistic. His data suggest that, over the centuries, homeowners have spent a fairly consistent percentage of their income on housing. Occasionally, however, they’ve broken out of that trend—and that, as The Economist (paid subscription required) notes, is what has happened during the past few years:
Until the late 1990s median house prices were 2.75 times median income. That ratio has risen to 3.4. Arguably, lower mortgage rates justify some of this rise. But even if you look at mortgage payments in relation to household income, many people look stretched.
And as I’ve written before, those buyers are competing with a record number of speculators, who account for more than one-fifth of mortgage originations in the frothiest markets.
Right now, the banks are falling over themselves to service these over-extended buyers with instruments such as interest-only mortgages, which recently have made up around one-quarter of residential mortgage originations. But that won't last. When house prices are rising, the banks always lend as much as possible to increase the value of their collateral. But when prices start to fall, the banks are usually the first to run for cover—which will mean an even bigger bust.
Chart courtesy of Robert Shiller via the New York Times
Posted by Stephen at 6:15 PM in Economics | Permalink | TrackBack (0)
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