Three top economists made a splash on the Wall Street Journal’s editorial page this past Monday with a piece headlined “Bubble Trouble? Not Likely.”
But the way I read the research underlying the Journal piece, a better title would have been “Housing Markets Are Stable … Until They’re Not.”
To show that there are no regional housing bubbles—and thus no reason for prices to fall—the economists in effect assume their own conclusion. They assume, without strong evidence, that buyers in each market will continue to expect the same kind of price gains that they’ve averaged over the past 60 years. If you expect prices to keep rising rapidly, you’ll be willing to pay a whole lot today. The market will be stable.
But what if buyers in, say, San Francisco suddenly turn pessimistic about the rate of future price increases? That certainly isn’t out of the question given how high prices are relative to rents, or incomes, or to prices elsewhere in the country. If they lose faith that the market will climb steeply ad infinitum, then their willingness to pay a huge sum of money now will plummet. And the market will tank.
That’s practically the definition of a popping bubble. By assuming from the start that such a thing won’t happen, the authors are assuming their conclusion.
A couple of Journal readers made something like this point in letters to the editor published today. So I called one of the authors to get his side of the story.
I spoke with Todd Sinai of the University of Pennsylvania's Wharton School. He was co-author on the paper with Charles Himmelberg, a research economist at the Federal Reserve Bank of New York, and Christopher Mayer of the Columbia Business School.
Sinai defended the paper. He said it's reasonable to assume that if house prices in, say, San Francisco have risen at an after-inflation clip of better than 3% a year for the past 60 years, that people will continue to expect them to keep going up at that rate for the foreseeable future. Why? Because, he says, hot cities like San Francisco are pretty much built-up, so people are competing to live there by outbidding each other for housing. That, says Sinai, can continue as long as there are rich people in other parts of the country who would really rather live in San Francisco.
I'm not so sure. It feels to me like San Francisco, San Diego, Los Angeles, New York, Miami, Boston, and other costly markets are pricing themselves out of reach. It seems at least possible to me that other people will start to reach that conclusion. If they stop expecting rapid house appreciation, their willingness to pay will fall. And the market could drop rather suddenly.
The authors certainly didn't persuade me that there's no bubble.
BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.