Tuesday, November 25, 2008

Has the bubble fully deflated?

The Wall Street Journal says two different methods of measuring home valuation disagree on whether there is still a housing bubble:
Two measures provide conflicting answers. Home price increases have traditionally kept pace with income, and that measure has returned to its historical average, suggesting that housing prices are close to returning to normal. But a separate gauge, which tracks home prices increases against rent increases, shows that the housing market is still overvalued by around 15%, suggesting that it has further to fall.
I'd say that rental prices, which are a substitute for buying, are the better measure. A third measure, which the WSJ didn't discuss, is inflation-adjusted home prices. Adjusted for inflation, housing is still way overvalued.

In fact, I'd say there's something fishy going on with the price-to-income ratio. For incomes to have kept pace with housing prices, there must have been a dramatic increase in real incomes. However, many economists like Paul Krugman have been repeatedly pointing out that median real incomes have not increased during this decade.

Are there any economists out there who want to take a stab at this?


  1. Many economists say many different things.

    One of the many things that many economists say is that hyper-inflation is due in the United States. The only question about the onset of hyper-inflation is with respect to timing. When will it happen?

    If this is true, as many economists say, then average rents as a percentage of incomes are likely to climb significantly.

  2. One might argue that rents were artificially depressed during the housing bubble. Anyone who could fog a mirror could buy, so rental markets were getting kind of soft. That's just a half-baked theory that I am pulling out of you-know-where, and I don't have anything to back it up..

    The question of incomes is a very good one though. I suspect that it depends a lot on who you ask. Middle class people haven't seen much at all in the way of income increases. The increases in income are mainly in the upper-income levels. I hear many economists say that the income disparity in our society is historically quite high right now.

  3. Hello Bubblemeter,

    I believe that Krugman was checking incomes against inflation so that might be the discrepancy.

    With all the bubble money floating around, realtor/broker income probably inflated the statistics a good bit.

    So, still think we have a lot of stuff to work out. Also a lot of the bailout plans will have long term effects of dragging this out. People will hold properties longer but prices will still be flat. Then as life happens they will lose them. So damage to the markets will be spread out for more time.


  4. There's an interesting psychological point to consider with regards to the two methods mentioned in this article: People will often pay more for the satisfaction of "owning" something. Now is that amount 15%? I don't know. But I would expect that if you a large number of people making the median wage in an area, you'll find a pretty strong pressure to hold prices close to the maximum affordable price based on that wage. There may be some that believe that price is too high and I'd expec tthem to be outbid by others who disagree. And there would be some who would place more value than that maximum price if at all possible, and they would be competing on basically equal ground to those basing prices on actual local wages.

    That said, we'll really need to wait and see what happens in the coming year what with all the 2007 2-year teasers and 2004 5-year interest-only periods coming to an end. I believe we'll see some price support but would feel honestly remiss in calling it a bottom.

    IMHO, and I'm not an economist, FWIW.