Beat the Press

Dean Baker's commentary on economic reporting


The Housing Bubble: Why Did the Media Miss It?

As the housing bubble starts to unwind people will be looking for villains in this economic disaster. There are many, with the list including Alan Greenspan, the bulk of the economics profession, and of course, the reporters covering the housing market.

As was the case with the stock bubble, there was very little attention paid to the underlying fundamentals in the market. Anyone who bothered to look at the data could have quickly recognized that the run-up in home prices in the years after 1997 had no historical precedent. From the early 1950s until 1997 (the years for which we have good data), house prices largely followed the overall rate of inflation. In the years since 1997, house prices have increased by 50 percent after adjusting for inflation.

If housing prices have tracked the overall price level for 50 years, and then suddenly take-off relative to other prices, this is a fundamental change in a key sector of the economy. Fundamental changes in the economy are not impossible, but they don’t happen very often. Unless there is very good evidence, it is reasonable to assume that there has been no fundamental change. In this case, that means assuming that the run-up in house prices is a bubble and will be reversed.

I have debated most of the key actors in this debate and none have given an explanation for the run-up in house prices that passes the laugh test. They would say things like people value the security of homeownership, that homeownership is the American Dream.

Did this first become true in 1997?

There is a limited supply of land and many of the areas with the most rapidly growing housing prices are uniquely attractive places to live.

Did New York, Boston, San Diego, Washington, and San Francisco first become nice places to live in the late 1990s?

Environmental restrictions have limited the supply of new housing.

Did environmental restrictions become stricter after the Republican takeover of Congress and many state houses in 1994? If they did, why has homebuilding been going on at a near record pace over the last 4 years?

Immigrants are pushing up the demand for housing.

How many recent immigrants are buying $450,000 homes (the median home price in places like San Francisco and Boston)? More importantly, didn’t we just have a national debate over Social Security, the main premise of which was that population and labor force is growing slowly?

Finally, I had my key check on the state of the fundamentals in the housing market: rents. If the run-up in house prices reflected fundamental conditions of supply and demand, then there should have been a comparable run-up in rents. There wasn’t. Rents rose somewhat more rapidly than the overall rate of inflation in the last 90s and the beginning of the current decade, but had nowhere near the run-up as home sale prices. More recently rents have trailed the rate of inflation. No economist has been able to give an explanation for how fundamentals could lead to a run-up in house sale prices, while having no noticeably effect on rents.

Good reporting would have prominently noted the evidence that the run-up in house prices would not be sustained, that it was a bubble. In fairness, the media paid considerably more attention to the possibility of a bubble in the housing market than they did to the stock bubble in the late 1990s, which managed to almost completely escape the notice of economic reporters. Still, most of the reporting had the same cheerleading attitude to house prices that reporters routinely apply to stock prices. Unfortunately, when the cheering stops, it is the homeowners, not the reporters, who feel the pain.


  • At 6:53 AM, Blogger Shag from Brookline said…

    The housing bubble has also impacted the property tax bubble, especially with reductions in federal aid to states, which in turn reduced benefits to cities and towns. If the housing bubble leaks, what may be the economic impact upon municipalities if property taxes also decline?

  • At 7:44 AM, Anonymous James Schipper said…

    Dear Mr Baker
    Houses are assets, and the price of an asset should have some relation to the interest rates. If interest rates are high, stock prices tend to be lower than when interest rates are low. Likewise, house prices probably vary inversely with interest rates. Since interest rates are quite low right now, it is not unreasonable for people to be willing to pay higher prices for houses. If interest rates remain low, which is highly unlikely, then this housing bubble is not likely to burst.
    Regards. James

  • At 9:18 AM, Anonymous Anonymous said…

    Dear Mr. Schipper,

    If your hypothesis is correct, then we should have seen an incredible runup in housing prices after WWII and into the 50's when interest rates were lower than even the recently seen lows.

    Regards. Bob

  • At 9:19 AM, Anonymous Anonymous said…

    Dear James:

    Your hypothesis needs work, cf low interest rates in the late 40's and early 50's.

    Do the math.

    Regards. Bob

  • At 9:52 AM, Anonymous Pryer said…

    Mr. Baker,
    Is it time to outlaw the 30 year mortgage? If 20 years was the legal limit housing prices would fall to accommodate what the buyer could afford. As a bonus, workers could save for their retirement and enjoy their working years rather than being indentured servants their entire professional lives. A good start would be to abolish the interest only mortgage, the negative equity loan, the 80/20 loan, and other instruments that act as fuel to the speculative fire. Your thoughts?

  • At 9:55 AM, Blogger Jessica said…

    Houses in my neighborhood have tripled in value in the past few years. It seems somewhat absurd.

  • At 10:36 AM, Anonymous Erik L said…

    The housing bubble is caused by the same thing that caused the stock market bubble- too much money in the world coupled with the sudden internalization of the message that X (stocks, house ownership) is a really good idea. Why is there too much money around? Maybe increases in productivity? Should central bankers have clamped down on this years ago? Could they even have? I don;t know.

    The real question, I think, is how fast is this bubble going to deflate. It will probably vary by region. It seems like a recession (isn't it about time for one of those?) could cause a pop in the coastal markets.

  • At 10:50 AM, Anonymous Anonymous said…

    Some might argue that Washington has become a more desireable place to live since the 1990s.

    Many DC neighborhoods (eg: Columbia Heights) are undergoing massive redevelopment. On the one hand, it seems like there is tons of new housing supply as boarded up rowhouses are being redone and new apparments and condos are popping up everywhere. All other things beign equal, this increased supply should keep prices down. Apparently, though, all other things aren't equal and the redevelopment that is occurring (along with new metro stops, grocery stores, and other services) has made these neighborhoods more desireable to live in--i.e., increased demand.

    There is certainly a lot of speculation going on by developers that is driving prices higher than they should be. At the same time, though, it seems clear that some part of the price increase of housing in places like Columbia Heights is justified by the increased desireability of the neighborhood.

    I have followed and think I generally understand the macroeconomic arguments that you've been making over the past several years, Dean, about the existence of a housing bubble and am pretty much convinced. I struggle, though, to understand how things happening in specific neighborhoods fit in to this big picture.

  • At 12:11 PM, Anonymous Joe Populist said…

    What everyone is coming to realize is that journalists are like politicians, or economists, or any other profession where job security is dependent on politics not production. Journalists tell us what we want to hear, which is that everything is great, and the economy is booming, and it will go on forever.

    And of course, it has been going on a long time, so the safe bet is to report the "good news".

    Of course, a lot of people like me are worried that we've built our economic security on a house of cards. The rich need to understand that they can't eat their money..if the economy slips, they can't protect their wealth, and they go down along with everyone else.

    Not something the rich want to hear.

    A burst of the housing bubble has the potential for far greater economic upset, as more working and middle class people have the high percentage of their saviings invested in real estate, not stock.

    Is there not a relationship between the housing bubble, the money supply, inflation, and the US dollar's position as reserve currency? The interest rates are low because the dollar is high...the US government is able to export it's inflation.

    So here's what it is, the US economy sells long term debt to the Chinese and the Arabs, which allows the Fed to keep interest rates low, and along with the deregulation of the mortgage financing rules, we have a glut of people rushing to buy a home, even 2 or 3 homes for investments.

    Of course, public loves this because of the low interest rates and liberal home mortgage rules, they can regularly refinance their home mortgages, and withdraw out large sums of cash to supplament their falling incomes.

    If for some reason, the US dollar loses it position as reserve currency, the dollar will fall, and interest rates will rise. Or China and Saudi Arabia will decide that it's not in their long term interests to continue putting all their bread in one basket, and move to encourage markets in other areas of the world, including their own consumers.

    If the dollar falls, interest rates rise, and instead of creeping inflation, we'll have galloping inflation. At that point, people who have borrowed out their home equity will have no savings at all. And the US industrial sector will have been destroyed, so no jobs in manufacturing for the Red/Retro states. All the well-to-do white liberals in the cities that are supposed to be part of "Metro" America, have jobs in think tanks, banking and finance, educational establishment, media, will be caught in a economy that can not longer afford their "services", and they'll find their advanced degrees worthless.

    I can't figure out why any all funny money, and I know a ton of people who think that the house of cards we have in the US is wonderful, a "miracle". As long as we have a majority of people who think it's great, we'll have journalists catering to them.

  • At 1:59 PM, Anonymous Anonymous said…

    Dear Mr Baker
    What about the unprecedented state of mortgage lending based on government backing and appraisals not in line with market fundamentals? I see here this is the fundamental change in the market, and when it goes pop it will make the S&L bailout look like a cookie grab.
    Dan in Madison

  • At 2:08 PM, Blogger Democracy Lover said…

    A good point was made earlier by shag from brookline. In many states, like New York where I live, the Republican administrations have amplified the effect of cutbacks in Federal aid to localities with cutbacks in State revenue-sharing with localities. As a result local governments have raised property taxes to cover unfunded mandates like Medicare and the higher health care costs required just to maintain needed services.

    When the bubble bursts, what happens to local governments? When the bubble bursts, we can expect that lots of credit-poor homeowners who have responded to the constant drumbeat of ads for home equity loans will suddenly join the ranks of the bankrupt - that's not going to do much for local tax revenue either.

  • At 4:47 PM, Anonymous Anonymous said…

    Re: "It is the homeowners, not the reporters, who feel the pain." Remember -- reporters are homeowners, too. They generally earn good salaries, but they will still be affected by the bursting of the bubble.

  • At 5:33 PM, Blogger Laurent GUERBY said…

    Hi, you might want to check this one on the FT:

    It's not bad economics, but as the comments show, UK is so desesperate to get cheap energy (after years of poor state planning) that it shows even in so called independant newspapers.

  • At 6:55 PM, Anonymous James Schipper said…

    Dear Bob Anonymous
    I didn't claim that low interest rates will always lead to skyrocketing house prices. I only meant to say that, without the current low interest rates, the rapid rise in housing prices would most likely not have occurred.
    Low interests could also explain perhaps why rents remain low. With low interest rates, landlords can build more cheaply. If it costs 100 000 to build an apartment and if interest rates are 8%, then the landlord needs 8 000 from his tenant just to pay the interest. If interest rates are 4%, he can charge 4 000 less.
    Regards. James

  • At 7:07 PM, Blogger mtnrunner2 said…

    James Schipper - I disagree with your premise. Assuming the CPI is correct, real inflation is the same. Thus, a period of lower interest rates is just due to inflation being burned out of the economy and would have no effect on prices. However, I disagree with the CPI data, since it excludes mortgages (30-40% of the budget of 70% of Americans), food, energy, transportation, education. Second, just because borrowing is cheaper, that doesn't mean people are willing to pay more money for things they buy on credit. Are you willing to pay 3x as much for a car when it is offered at 0% APR? Come on James, even you have to laugh at your own theory!

    Don't blame reporters for not exposing the bubble. They are reporting what they are told by realtors and economists. Most economists are optimists, or work for organizations whose interests they must promote. Housing bubble advocates are in the minority, and not readily available for interviews. Only a handful of economists today know that housing will drop 10-15% this year, and more next year. In San Diego, real estate analyst Rich Toscano,, has been interviewed but not quoted because he doesn't hold an economist title. So the media has only realtors, cheery economists, and Dataquick data, which shows median price is still going up.

    Reporters do a poor job when they don't dig into the numbers. For example, median price is going up because the lower-end buyer is squeezed out by rising interest rates, while higher-end homes are still selling. Realtors are telling us that each individual home is worth 5-10% less than last summer, but this doesn't show up in the median figure. Reporters also miss the boat on the employment figures. They cheerily report higher employment, but don't tell us about the quality of jobs: mostly lower-paying, and dependent on housing (contracting, realty, lending, and various retail related to consumer spending of home equity).

    Economists get the blame for not shedding the light. Most economists represent the marketing goals of their organizations. For example, the NAR economist, David Lereah, has a dual role of telling the NAR the future of housing, but must promote housing to the public.

    I also want to note that most economists have trouble seeing around corners. They cannot identify deviance from trend, straying from fundamentals, or the possibility that tomorrow is different from today. How many economists have figured out and told the public that days on market and rising inventory are leading indicators of changes in price, and are now portending a price decline?

    The economists from the UCLA Anderson Forecast, who spoke out about the housing bubble for several years, were wrong so many times, they've retreated. Now they claim that they focus on employment and income growth, not real estate. It takes courage to go against the herd, and be ridiculed, and these guys wimped out.

    May I suggest to all that you check out Sell Now, by John Talbott, a former visting scholar at the UCLA Anderson School of Management? He was a forward looking economist with the insight and courage to write a book about the housing bubble last year. He writes about the national implications of the bubble busting, and the possible failure of Fannie Mae, Freddie Mac, and the derivatives market.

    In either case, a recession is upon is later this year or in 2007. Not only are wages stagnant and consumer spending receding, both of which are leading indicators for manufacturing and capital spending and stock market profits, but the prevalence of exotic loans is going to put lots of recent borrowers into foreclosure.

    The exotic lending is nationwide. Have any of you ever read of a housing bubble in Omaha, NE? No, because they don't have one. But I spoke w/ a realtor in Omaha today, who told me inventory is double over last April, while sales are flat. Foreclosures are up, and he blames this on people refinancing their homes, at 100%, with adjustable mortgages. Now they cannot pay. This has gone on nationwide, and this is the problem I keep writing about at the pigginton site, but no one else is saying anything about this. The housing bubble is localized, but the exotic lending bubble is nationwide!!!

    Move your money out of stocks, for they are high now. Remember - buy low, sell high. Get ready for the recession. Move into CDs, for they pay about 5% now, and sit out on the sidelines. Diversity into commodities index funds, some foreign currencies (yen, yuan, euros, swiss francs), and you should be set until the market is so bad, that no one who is sane touches real estate or stocks. Then you take your cash and get back into the market.

    Oh, and come visit us at the piggington site if you are interested in SD real estate and credit markets.

  • At 10:06 PM, Anonymous James Schipper said…

    Dear Mntrunner2
    When I buy a product, I try to pay the lowest price, but I have to take cash flow into account. If I can afford to buy a car on credit when the interest is 5%, that doesn't mean that I can also afford to buy it when the interest rate is 15%.
    Housing is different from most other products in that houses can't be imported and because the number of houses that can be build in a given year is only a small percentage of the total housing stock, which means that supply can't respond that fast to increasing demand.
    Most adults start their lives away from their parent's home as renters. The lower the interst rate, the sooner they may start to buy a house. This means that more people are leaving the rental market and entering the housing market. That must explain in part the fact that rents haven't gone up that fast.
    The distinction between real and nominal interest rates is of course valid, but for cash flow purposes, nominal interests are more important in the short term. Suppose that Paul has a debt of 100 000 and an income of 50 000 and that the interest rate is 5%. He then has to pay 5000 in interest, which is 10% of his income. Now suppose that inflation is 10% and that the interest rate rises to 15.5% as a result of that. Paul's income rises to 55 000. His interest payments are now 28% of his income. In other words, higher nominal rates create cash flow problems.
    Regards. James

  • At 1:04 AM, Blogger NetSkrill said…

    This comment has been removed by a blog administrator.

  • At 2:12 AM, Blogger hm said…

    Those like James Schipper who argue that low interest rates justify high home prices -- in effect arguing that homes should trade like long-term bonds -- fail to see the importance of the fact that most home purchases are made with degrees of leverage that would not be allowed in the bond market.

    Purchasers who buy long-term bonds when interest rates are low must consider the risk that they will be forced to sell at some time in the future when rates have risen, causing proportionate decline in bond market values. And because of that risk, no brokerage will allow naive retail investors to purchase long-term bonds with anything like the 10:1, 20:1 or even higher leverage being allowed in the home mortgage market.

    If you believe that the decline of mortgage interest rates in recent years justified the increase in home prices, you must also believe that if rates return to their earlier levels, then home prices should too. Since the risk that interest rates will return to their earlier levels has been obvious and fairly high, and that will mean economic disaster for those with high mortgage leverage, how could it have been wise for anyone to buy at the higher prices? The proper price for an asset must reflect such risks.

  • At 7:36 AM, Anonymous James Schipper said…

    Dear HM
    Houses are not bonds because bonds are pure investments whereas houses are a combination of investment and consumer durable.
    Low interest rates are a necessary but not a sufficient condition for a housing bubble.
    People don't always evaluate risk right, least of all house buyers, who are in the main non-professionals.
    Regards. James

  • At 10:02 AM, Blogger Γεώργιος Ιακ. Γεωργάνας said…

    One could argue that the price of risk has also fallen in the last ten years, what with China and India moving in the world economy and trade mainstream together with Eastern Europe and much of Central and South America.
    Moreover, the record of independent world central banks in managing the macroeconomy in the major world economies is clearly better than the record of elected governments had been.
    Wars are at half as evident globally as they were ten years ago.
    Market-oriented reforms, especially in economies that happened to be heavily regimented (China, India, Eastern bloc) have made equilibrium in those economies much more stable than in the past.
    All those trends could justify increases in house prices and smaller increases in house rents

  • At 1:30 PM, Anonymous howardl said…

    I don't have a well developed theory for this point, but my "anecdotal" observation of interhousehold decision making suggests that increased female participation in the labor force has led to an sharp increase in the "house-spending" budget. Naturally, one might ask, why did the female participation start growing in the 70s and 80s, and the housing market not for another 15-20 years? Certainly part of the lag is that wife's wages were not counted in mortgage qualifications for some period of time.

  • At 1:27 AM, Blogger Steve Sailer said…

    I'd divide the question into two: Why has there been a general national housing market inflation. And why has there been a hyperinflation in certain coastal cities?

    The money supply seems to provide much of the answer for the general national question, along with immigration boosting overall demand.

    For the coastal bubble markets, there is a physical limitation of deep water preventing suburban expansion in one direction. Most can expand only about 180 degrees, compared to 360 degrees in inland metropolises like Dallas and Atlanta, so the supply of subdividable suburban land is only half as good.

    Also, legal immigrants from Asia _are_ buying lots of the expensive houses in California. They often have 3 to 5 incomes per household due to their extended family structures, which allows them to outbid American-born nuclear families that have no more than 2 paychecks per household.

  • At 5:49 AM, Blogger Dr. Ernest Hamsag said…

    The main reason of the housing buble is the lack of balance between consumption expenditure and savings. As the capital income was groving much faster than the salarial income in the last 20 years there is an excess of savings. This excess is causing an inflation of the financial markets. Since the last crisis (beginning 21 century) investors trust less the financial markets, so the excess of savings are invested in housing, which increases the prices
    Dr. Ernest Hamsag

  • At 9:09 AM, Anonymous Anonymous said…

    Re the question, why do journalists over-optimistically cheerlead the real estate bubble:

    You fellows overlook the obvious. Real estate advertising is a large psrt of newspaper advertising. Journalists are not allowed to poop their cusomters' party.


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