Dr. Andy

Reflections on medicine and biology among other things

Tuesday, August 09, 2005

"Housing bubble" standards

Warning: I know less about economics than I know about politics, so use caution in trusting my posts on this subject

As a relatively new homeowner I am interested in all the buzz about whether or not we are in the midst of a housing bubble. As a scientist (or scientist want-to-be) I am concerned that the concept of "bubble" is not well defined. To some, any decrease in the rate of housing price inflation is taken as evidence of a bubble, which is clearly not what people have in mind.

As an example, noted economist Paul Krugman wrote on Monday:
Bubbles end when people stop believing that big capital gains are a sure thing. That's what happened in San Diego at the end of its last housing bubble: after a rapid rise, house prices peaked in 1990. Soon there was a glut of houses on the market, and prices began falling. By 1996, they had declined about 25 percent after adjusting for inflation.
Is that really a bubble? I'm not so sure. If you go to the BLS website and use the handy inflation calculator, you'll see that a cummulative inflation was 20% in the intervening 6 years (i.e. a dollar in 1990 was worth $1.20 in 1996). Looked at in those terms the "bubble" looks a lot less impressive. Nominal prices declined about 5% over 6 years; not the rate of return homeowners are looking for, but not exactly a crash either.

If I tell you that house prices nationally will decline about 5% in nominal turns over the next 6 years, I don't think that would panic anybody except speculators. Those of us living in our homes and paying our mortgages each month will keep on doing that. Mind you, I'm hoping for some appreciation but such a minimal decline (remember, mortgages are in nominal dollars) won't be a huge deal

Whenver someone warns me about the "housing bubble," I make them define what a bubble is. 20% decline in nominal values? 25%? Those kind of drops seem unlikely to me. If what you mean by bubble is flat to slowly increasing prices or even a modest decline (say <10%) then sure maybe we are in one, but to me that isn't a bubble.


At 1:18 PM, Anonymous Sheila said...

Good points. And people rarely mention that declines in house prices hit high-end houses the hardest, that is; a million dollar house will lose a greater percentage of its value that will a "starter" house.

My low-end-but-in-a-safe-and-pleasant-neighborhood house has appreciated 80% (yes, 80%) since I bought it in Feb 01. A dip in prices isn't going to phase me at all.

At 5:21 PM, Anonymous Jason said...

It's doubtful that there is a "national" bubble, and I doubt highly there is a bubble in the Steel City, but localized bubbles probably do exist out there and will burst at some point.

As mentioned in the comment above, a 80% appreciation in 6 months?!? Is that rational? (Is it even real?) I'd be worried in a market like that if I was looking to sell.

Also, if "high end" houses are more susceptible to downside of a bubble it should also mean they appreciate faster on the upside. If the "low-end-but-in-a-safe-and-pleasant-neighborhood" house appreciated 80%, then the "high end" should have done even more...


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