EclectEcon

• "The news is not good for homeowners. According to our data, homeowners face substantial risk of much lower prices that could stay low for a long time after. It’s notable that until the recent explosion in home prices, real home prices in the United States were virtually unchanged from 1890 to the late 1990s."
• Real house prices are higher now than they have ever been over the past 120 years.
• The ratio of real house prices to real rental rates is also higher than it has been over the same time period.
• "Interest rates are not the explanation, as some have suggested (notably Himmelberg, Mayer and Sinai 2005). The rent-to-price-ratio downtrend is not matched by a downtrend in real long-term interest rates, here measured as a long-term U.S. government bond yield minus the previous year’s CPI inflation rate (see Shiller 2005). Also, real rates today, while much lower than in 1980, do not appear low by historical standards."
• "[T]here is substantial evidence that there is a strong psychological element to the current housing boom. While the boom may continue for some time, the psychological element is likely to die away as thinking changes and current folk expectations for further price increases are lost. ...[T]he current home price boom is best thought of as a social epidemic: a fad of sorts. And yet social epidemics are not even mentioned by most of those who say reassuringly that there is no reason to worry about home prices. Social epidemics can unwind sharply as psychology changes, suggesting the worrisome possibility of a rather hard landing."

An unprecedented run-up in the stock market propelled the U.S. economy in the late nineties and now an unprecedented run-up in house prices is propelling the current recovery. According to Dean Baker, like the stock bubble, the housing bubble will burst. Eventually, it must. When it does, the economy will be thrown into a severe recession, and tens of millions of homeowners, who never imagined that house prices could fall, likely will face serious hardships.

A futures market will generate price discovery for this: market expectations. If the futures market in effect concludes that real estate price declines are likely, then we might see backwardation in the futures market: futures prices lower than today’s cash market prices and futures prices declining with horizon. In this case, speculators who expect prices to fall less than the market expects will tend to be long the futures market. Speculators who expect prices to fall more than the market expects will tend to be short the futures market. Hedgers will take sides depending on their preexisting exposure to the real estate market.

I find it interesting the number of complete fools hopping on the "no bubble bandwagon". The 2% maintenance figure is of course questionable, but I am very surprised that no one questioned the key assumption that house prices will rising 6% a year from now until eternity.

It simply does not wash. Here is something that does. Long term prices of houses simply can not rise above people's means to pay for them. That is a simple economic fact. Here is another simple economic fact: Family incomes are falling. The negative savings rate and rising foreclosures are more proof of stress in the system. Real wages have fallen for 4 consecutive years and that includes some pretty fat bonuses of the Wall Street fat cats at the top end.

The fact is that home prices are several standard deviations above norm in terms of affordability in many locations. Gary and Margaret Smith are simply making the classic mistake of projecting into the future what has happened over the last 10-20 years as if it that period is the norm. That is the same type of mentality used to justify the Nasdaq bubble in Spring of 2000.

At 6% appreciation a year home prices would double again in 12 years. That nifty 3 bedroom shack in California now priced at $800,000 would supposedly go for $1.6 million in 12 short years. That $750,000 condo in Florida supposedly would be going for $1.5 million 12 years from now. Sorry, I do not think so. Who could afford to buy them? Buyers are already stretched.