Greenspan dismissing the bubble is laughable. He created it. And he created it on purpose in order to stimulate debt driven consumer spending so as to keep the 2001 recession both relatively mild and short.

Just not sure what bubble the Fed can try to use now that the consumer is tapped out. Ideally we'd get a Cap-Ex bubble from the corporate sector (which might actually have long term benefits for our infrastructure) but I don't think the suits are going to fall for that. In fact the government tried to stoke this by offering a tax break on repatriated profits. Led to the companies hording cash or using it to buy each other, spiking M&A activity but leaving the economy less diverse than it was before.

thosethingswesay.blogspot.com

Further declines in prices, lead to more defaults.

I'm not sure I follow why that would be. I can see why rising interest rates might cause those with ARMs and other variable rate loans to default. But why would the valuation of the home affect the owner's ability to pay back an existing loan? If anything it seems to me it would decrease the owners property tax burden.

I guess its possible the owners equity could get erased and they may suddenly find themselves upside-down in the loan, and the lender may sting them somehow for that.

Could you explain?

Dean you were the first to convincingly call the real estate bubble, in 2002. Good work.

What have you done for us lately?
;-)

Defaults are usually caused by some setback, an illness, job loss, etc. A decline in home value means that you can't refinance your mortgage to weather the setback.

It is a big problem for the securitized mortgage markets and the investors (including pension funds and insurers) who hold the instruments. All home values will suffer when liquidity dries up, but some more than others. There will be fewer qualified buyers. Real estate values will hold up better if there has not been a speculative run up locally and if local circumstances keep up demand. Your part of Chicago may qualify on one or both counts. The same circumstances may not apply to new housing in the exurbs which may be hit by a combination of higher interest rates, fewer qualified buyers and even higher fuel costs.

There are limits to how much new housing can be built in San Francisco, Boston, etc. due to zoning regulations, including those pertaining to multifamily units, minimum lot size, etc. The teardowns in Chicago described by an earlier commenter would be difficult or impossible, at least in Boston.

People also live longer, and homestead and senior citizen property tax breaks reduce the incentive to sell.

“Home Prices Are Falling Like Almost Never Before”

EXCEPT: THEY AREN'T

average and median sale prices of existing home sales slumped last year but have been rising steadily and modestly every month since january and as of june were slightly higher (+0.3%) over where they were in june 2006.

That's not to say the situation is the same in South Florida, say, where for some time there seemed to be an endless ability to build more luxury condo units to sell the investors (often just speculators), or in various housing markets characterized by more and more suburban sprawl, with few limits on development.

It is true, Dean, if I may use your first name, that you have been on record since at least Aug 2002 that housing prices have been overvalued. However, I don't think you predicted in 2002 that the alleged bubble would pop in 2006-07. Since prices continued to rise for several years after your call, and a lot of bets contrary to the bearish call paid off lucratively, the prophetic aspect of the call should not be overstated.

I also question the use of the term "bubble". I recall looking a couple of years ago at the literature on bubbles and I thought it was not a settled question as to how economists define a bubble and thus it is not self-evident now that the housing price run up was a "bubble" as opposed to a more modestly labeled event. I don't claim the market was perfectly rational the past 10 years but I think there is more to the spectrum than a) perfect rationality and b) bubble.

The indices of housing prices do show the rise in housing prices that you report. Personally I prefer the OFHEO index because it tracks back only to 1975, whereas I reject the use of century-old housing prices in the Shiller graphs as having anything meaningful to contribute to today's analysis. There was a lot more buildable volume a century ago and many fewer people, so the supply (including not only built units but also buildable vacant land and airspace) and demand have changed so meaningfully since then such that I believe data that old are worthless. Pre-mortgage deduction, pre-seoondary mortgage market, that housing market, on a macro basis, seems very different to me than the market of the last 40-50 years.

Further there is the hedonic aspect: people require much more sq ft per person in 2007 than in 1907 or 1957 from their housing stock; indoor plumbing, central air, etc., etc. - all of which either changes the supply demand ratio per unit measured, or changes the value and cost of each unit. But the indices, even though they use repeat data points, by their own admission do not attempt to capture the hedonic aspect of the units whose sale prices are captured. Thus teardowns and rebuilds, or additions, do not flow into the measurement of what is a house. The indices measure dollars paid per house not per square foot which might tell a more conservative story. For example, my own house will sell for double what I paid for it 10 years ago, but I have converted two attics and a basement into bedrooms and an office and added a deck. Since I keep track of my expenses on quicken, I can tell you that I will not make a profit despite the nominal doubling of purchase price that the indices will pick up - any one who buys from me will be buying about 150% of the house I bought in terms of finished square feet. That 50% difference (200% - 150%) over 10 years is in line with inflation, not far in excess of it. Since people on average tend, in my estimation, to improve their housing stock rather than let it degrade, housing prices - measured per housing unit, as opposed to square footage -should, all other things being equal, rise over time as that process plays out. Failure to attend to the hedonic changes means that the indices are limited in the information they convey.

So too, while the indices show price appreciation, they do not purport to explain what caused the price appreciation. And I have not seen analysis that rigorously examines the factors behind it such that one can conclude with confidence that it is a "bubble" -- which to me conveys a sense of demand run amok with no reason behind it other than pure speculation. Demographic factors stimulating second home purchases have provided a substantial impetus to increase demand the past several years and many of the markets where there has been the highest price appreciation are those where second home buyers have been especially active; those buyers in turn create demand for services, retail, etc. that attracts additional demand for residence and so on. There is no model I know of that unpacks all the causes of price appreciation - demographic, hedonic, structural changes in mortgage financing, etc. - and establishes that a purely speculative bubble has occurred.
Due to the limits of the data and analysis to date, I respectfully withhold judgment on the "bubble" characterization and I am skeptical of the doomsday prophesying of Prof. Shiller that a 75% drop in prices will occur between now and 2011-2012.

Economist Dean Baker was so worried about a housing bubble that he sold his Washington, D.C., condominium . . . [in 2003] . . . . Now, about two years later, he's still waiting for the bubble to pop. csmonitor 4/4/2005

If it pleaseth thee, Lord, make those insane, irrational home prices fall! Do that Lord and I'll never ask for another thing; I promise.

I'm not sure why one would prefer an index because it doesn't go back before 1975, but if your intent is to shorten your frame of reference, you're welcome to do so. I just don't see any rationale for it.

As far as the issue of quality improvements on existing homes, a Fed study tried to make this argument a few years back. We actually have good data on spending on quality improvements, it's the wrong order of magnitude and has been falling relative to home sale prices over the last decade (see this CEPR study).

The timing of a bubble is determined by pyschological factors, which I would not claim to be able to predict. I began being concerned about the stock bubble in 1997. For three years it kept rising. I first took note of the housing bubble in 2002. If I was a better economist I would have noticed it two years sooner.

I think we have to keep intent in mind here. It's an economist's job to say whether there is or isn't a bubble. Not to give a timing call.

Sometimes, timing matters. If you're predicting where interest rates will be, you're usually doing it on a 12 month timeframe. If you're an analysts making earnings projections you're working 1-3 years out.

But when you're doing this kind of work the idea is to answer "is there right now, or isn't there right now?"

Dean noticed the housing bubble before a lot of people.

It was a description, not a trading call. When it popped is another question entirely.

thosethingswesay.blogspot.com

You refer to "the housing bubble" as an observed fact - but what exactly is a "bubble" - is it any thing more than what Potter Stewart said about pornography - "I know it when I see it"? Your comment assumes as a fact what is actually in dispute - the existence of a bubble across the entire housing market of the United States, which is a multitrillion dollar market. I don't believe the data support such a broad conclusion.

BIG TROUBLE AHEAD...

Historically, housing prices have increased by the rate of inflation PLUS 3%. This rule still exists, the problem is that the Government is lying about the inflation number. If you use the CPI equation from the Reagan years, you would end up with an inflation rate of 9% to 11% over the past 5 years. Housing went up accordingly. The Federal Reserve dropped rates and kept them low due to "low inflation" BECAUSE they don't include house prices in the equation. Your house may have doubled, but our currency has been halved. GOLD and HOUSES went up together, the dollar dropped.

The Bush administation has turned the dollar into a peso. IT is great for Wall Street since multinational companies are getting paid in strong foreign currencies. Half the earnings on the S&P were due to currency exchange. It is all a mirage and as Bob Rubin has said "the day of reckoning" is coming.

For evidence of falling houise prices, you can look to the realtors metro area indices. These show extraordinary year over year (YOY) price declines in a large number of metro areas. The data only runs through the first quarter. It's a safe bet the second quarter data will look considerably worse.

Also, it's important to keep in mind that this data does not adjust for changes in the mix of homes sold. With the collapse of subprime lending, undoubtedly sales of low priced homes have fallen off more than higher priced homes. This will skew the median upward. Also, it is a common practice in many markets for sellers to give kickbacks at closing in the range of 2-3 percent of the sale price. This also will not be picked up in these measures, which rely on contracted prices.

Another source is the new homes sales data which shows a 2.2 percent nominal decline YOY. The Case-Shiller index, which tracks resales of the same home also shows declines for many of the 10 cities for which it exists.

As far as the credibility of Mr. Mozilo in saying that he had never seen price declines of this magnitude, this is not a self-serving statement. It is Mr. Mozilo's job to know the housing market. That is what he gets paid tens of millions of dollars to do. When he expresses surprise at a sudden plunge in house prices, as he appears to be doing, it is effectively saying "I am a complete idiot." It does not get him off the hook with his board and shareholders.