Arnold Kling  

Housing Bubble, Again

Market for Body Organs?... Outsourcing Winners and Losers...

Brad DeLong links to this scare piece, although I don't know why. The article is not particularly well researched. For example, the author writes,

What makes the current frenzy especially dangerous is that every relevant institution has an incentive to play along. Who, after all, is likely to say stop? Not the realtors. Not the banks, any longer. Not Fannie and Freddie or the private secondary-mortgage operators, who are turning vast profits on the backs of the bubble.

In fact, Freddie Mac and Fannie Mae have an enormous incentive to not get caught in a bubble. So do the private mortgage insurance companies. If house prices collapse, then mortgage defaults will rise, and these companies stand to lose money.

Finally, the very group that is most blamed for a bubble--speculators--has an incentive not to overpay for houses. The speculators will lose during a bubble.

Will house prices hold up in every market in the country? That is unlikely, just as it is unlikely that stock prices will go up in every industry. However, the ratio of house prices to rents overall is sustainable.

For Discussion. Which local housing markets are most overheated, as indicated by price-to-rent ratios?

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COMMENTS (12 to date)
rvman writes:

Price to rent ratios aren't necessarily indicative if rents continue to rise with the price of housing. If house prices rise, owners of rentals will raise rents, if for no other reason than because the price of the substitute good for their customers (purchased housing) will have gone up, and the landlord's opportunity cost of renting rather than selling has increased.

What SHOULD be predictive would be a spread between the marginal cost of building a new unit(including land and permits) and the price it, and equivalent existing housing, sells for. What is happening there, I have no idea.

Besides, as was said in the original discussion, 300 is just too high of a spread. 200 - 250 is more reasonable. 300 barely covers actual costs (property taxes, maintenance, management fees) leave alone the (high) cost of capital.

Eric Krieg writes:

New York and San Francisco, of course. Both areas have extreme land scarcity, and both are extremely anti-development.

The Chicago housing market is the one that should be the temperature gauge. Chicago has a decent amount of land available in its outlying areas, and it is generally pro-development in the closer in areas and the city itself. Prices in the Chicago area are up, but not at unsustainable rates. Lynne Kiesling says that in the Chicago neighborhoods that she is looking in, prices peaked in 2001. There is that much new development and rehabilitation going on.

Lawrance George Lux writes:

A new matrix enters the equation with the heavy increase in lumber prices, as today reported in the NY Times. A Thousand sq. of plywood has gone from $170 to over $500 in the last price rise. This is raw lumber cost, but will after normal profiteering by all concerned, will raise the monthly mortgage payment by $70-110 on new-built homes, while raising re-modeling costs by thirty percent. The Economy is going to lose the Construction sector within 12-14 months, unless Supply Costs come down. lgl

Robert Schwartz writes:

Not in Central Ohio. No bubble here.

Ann Holden writes:

Mortgage Servicers don't like foreclosures?
I believe that that they do in fact thrive on foreclosures.

Ann Holden writes:

Here is the link.
Mortgage Servicing Fraud

Arnold Kling writes:

Ann writes, "Mortgage Servicers don't like foreclosures?
I believe that that they do in fact thrive on foreclosures."

Only a handful of bandits thrive on foreclosures. The typical mortgage servicer loses. And the mortgage insurance companies, Freddie Mac, and Fannie Mae lose big time.

dsquared writes:

Two points:

Finally, the very group that is most blamed for a bubble--speculators--has an incentive not to overpay for houses. The speculators will lose during a bubble.

Heh. Speculators also had an incentive not to overpay for dot com stocks, for all the good it did us.

And second, I think that the argument from falling house prices to increased defaults needs careful spelling out. I agree that the empirical connection is there, but it's entirely possible for households to be in negative equity without defaulting, and it's not obvious to me that the net effect of higher levels of business during the boom, net of higher default rates during the slump, would be negative on balance for any of the players you describe.

Arnold Kling writes:
I think that the argument from falling house prices to increased defaults needs careful spelling out. I agree that the empirical connection is there, but it's entirely possible for households to be in negative equity without defaulting

What happens is that people tend to pay their mortgages as long as they can afford to. When they get divorced or lose their jobs, they can no longer make the payments. At that point, those with positive equity sell their homes and pay off their mortgages. Those with negative equity hand over the keys to the lender.

At Freddie Mac, where I used to work, we called this the default option, and we used option-pricing models to predict default on the basis of equity. The models worked very well. And Freddie Mac took big hits when there were weak housing markets in Texas in the 80's and in other markets in the early 90's.

Frank DeWith writes:

Vancouver Canada is pretty hot. Here, vacancy rates have been rising as renters have taken advantage of "low monthly payments" to buy in new condo towers.

But the price-to-rent ratio can be somewhat skewed. As vacancy rates rise, landlords are very reluctant to lower rents on vacant apartments as existing tenants would also demand decreases. Instead, landlords first offer incentives such as move-in bonuses, referral bonuses and free extras such as parking that they might have previously charged extra for.


Anonymous Banker writes:

RE: California is headed for a massive real estate crash in the next 12 months and it's inevitable.

California is at the end of its 10-12 year recurring cycle of running up real estate values, and is now due for a correction. However this time, there are factors in play that will act like an accelerant on the decline in California real estate values like nobody's ever seen before.

In a nutshell, here's Why:

Real estate values have been artificially "pumped" up by the presence of interest rates that are at 50+ year lows.

Despite these very low interest rates, records are being set for the number of bankruptcies filed for almost every year of the last three years. See related article at

Increasing foreclosures and REO's are appearing in the same states (Texas, Arizona, Colorado, etc.) that immediately preceded our crash the last time. Foreclosures are up 400% (over 2000) in Dallas Texas per the article here...

California has a disproportionately high number of 1031 tax deferred exchanges. Consequently, and in order to avoid paying taxes, tens of thousands of real estate investors have allowed themselves to be suckered into buying (i.e., increasingly leveraging into) larger properties that are significantly overvalued.

California still has an ENORMOUS and UNRESOLVED budget crisis

California still has an ENORMOUS and UNRESOLVED energy crisis

If you think records were set for fixed rate mortgage refinancing, you're right. But what you may not know is that the number of homeowners who've taken out Home Equity Lines of Credit (HELOC's) on their homes (ever notice how many people "more" people are driving expensive cars these days despite the cost of gasoline) is far more than the number of people who have locked in low fixed rate mortgages. Keep in mind, ALL HELOC's (and credit card debt) are adjustable! When interest rates rise, these homeowners will get blown out of their homes, and when that happens, their low fixed rate mortgage will disappear (remember, fixed rate loans are not assumable!) and lenders will be happy to lend it out again at a much higher rate. Maybe now you can see why lenders are so happy to give you a HELOC that far easier to qualify for than a regular home loan. And I'll bet you didn't know that in 2001 alone the Prime rate dropped ELEVEN times that year. Imagine what will happen if the Prime Rate increases ELEVEN times in any one year!

The disparity between what it costs to own versus rent the same property has become nonsensical economically. I've heard from too many Californians about the so-called "sunshine tax", the excess amount people are willing to pay to live in California, and how it will always be that way. Well guess what, they're wrong. The only people coming into California are those coming from the south looking for a hand out. Anybody with enough money to rent a truck and leave California is doing exactly it and here's the PROOF!

If you go to (as of mid-April 2004) and get a one-way quote from Las Vegas, Nevada to San Diego, California for their largest truck, it costs $200, but if you get a quote "leaving" San Diego for Las Vegas, the amount is well over $1,500!, a more than 700% increase! That's because so many of their trucks are leaving the state compared to coming in, that they have to price them for what they have to pay people to retrieve them and bring them back. I checked other cities that I've heard Californians are moving to and the rates all reflect the obvious, that the net migration pattern for San Diego (and likely other parts of California) is that tons of people are leaving! With more people (with assets) leaving the state, and more illegals arriving, in an increasing interest rate environment, economically, it's going to get very ugly for California!

Want to verify what I'm saying, get a quote from at the link below:

Other interesting articles related to this topic are at:

It's about the World real estate bubble, but it applies here.

Britain's housing boom threatened by record bankruptcies

How healthy is the US banking system?

Housing Bubble

Housing Bubble

Housing Bubble

Problems with Fannie Mae and Freddie Mac

Housing Bubble

Housing Bubble

Watch for news reports of slowing real estate sales that should begin in the 3rd quarter 2004 through the 1st quarter of 2005 immediately following any increase in rates by the Federal Reserve. Two increases by consecutive meetings of the Federal Reserve will officially launch the begining of a real estate crash in California and more so in San Diego, if not for the actual impact of the increase then for the psychology of back to back increases.

Remember to ask yourself this question about those who say there's no real estate bubble: What's their bias? The only people who are denying the obvious are those who stand to profit from it, real estate agents, lenders, title companies, and anybody who's so leveraged that any small decline in property value will destroy them.

Dan Spillane writes:

"Scare story"??? Not.

The linked story really isn't that much of a scare story--considering Greenspan warned about the collapse of the whole mess in front of Congress.

What's missing from the analysis is a key aspect--possible side effects related to the increased use of automated appraisal programs during the last few years of the so-called bubble.

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