BS asked after class if we are in the midst of a bubble in residential real estate.
First, let me emphasize that bubbles are hard to spot when you are in them.
Secondly, I tend to be overly optimistic. I was in denial about the bubble in home prices in 2006-7.
Third, my answer, without hesitation, is yes and it's going to end badly.
Houses being flipped is a very bad sign. That behavior should not be profitable. When it is, it's because there's something amiss.
Also, in the pandemic/lockdown recession, there is no general shortage of income (which is what is so crazy about the "Biden stimulus package"). There are absolutely some types of workers who are hurting, but that's specific rather than general. There is also less to spend your income on these days. This is why we saw bubble behavior and herd behavior with things like GameStop (and other stocks).
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The data to look at for this is the Case-Shiller U.S. National Home Price Index, available on FRED. Remember what I taught you: download the data (if interested) and don't look at it until you log it. It's reasonable to think home prices will trend through time.
What this shows is that the bubble is still small and of very recent vintage. Growth rates for home prices held quite steady at about 0.4%/month for the 9-10 years up until February 2020.
And then COVID-19 hit. For obvious reasons, a lot of people wanted to move to less populated areas, with less pervasive lockdowns. Fair enough. But we also had a government pursuing an expansionary fiscal policy (2 stimulus packages under Trump), and another one under Biden. The average growth rate is double since the start of the pandemic/lockdown.
Not.Prices.Doubled ... Growth rates doubled. That means that in a graph of logged data, it's slope is getting steeped. In the huge bubble that popped in 2006, home prices did this for 8-9 years before the bubble popped. Of course, they're called bubbles because they can pop at any time, so we should not expect this current bubble to go on that long.
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What do we do about bubbles? Prick them. Macroeconomically, we do this by raising interest rates until less informed buyers get the message to stop overdoing it. Yes, bubbles do seem to be preferentially caused by the buyers, not the sellers.
Except last week, the Fed announced that they don't see interest rates going up until 2024 at the earliest.
I get it. COVID, right? But, as always, there are tradeoffs in the real world, and we need to be seriously weighing low rates to promote demand, versus high rates to discourage it.
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I also mentioned that there was a video about this that I'd lost in the depths of the internet. It came out in April 2006, a few months before markets started peaking in Miami and Los Angeles (the first places where the bubble collapsed). It showed a home price index going back to 1890, plotted as a virtual roller coaster.
I have looked for it in the past, but have been unable to refind it. Stuff disappears after a while on the internet. But it always pays to keep looking, because people who download things often re-upload them when they go missing. So today, it was easy to find again. Check it out:
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But, you might ask, didn't we regulate these markets more seriously to address problems?
My opinion is that all of that, like Dodd-Frank, was just regulatory theatre. Plausible action that's just make believe. This is not an uncommon viewpoint amongst macroeconomists and financial professionals. Now, having said that, this does not mean I have a lot of great ideas for better regulations that they might have tried. I don't. The fundamental problem is that humans are goofy, buyers' herd behavior and ignorance creates bubbles, and we should get used to them as a natural albeit nasty phenomenon.
That thing in the background that looks like one of those isolated mountains we get in Utah is actually the rest of the roller coaster you just rode.
Fun Fact: I might be only person you know who's been on not one but two roller coasters when they broke: at the top just before the first drop on an outdoor one, and near the top but going full speed on an indoor one in the dark.
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P.S. I always like to relate to student two personal stories about the crisis.
First, my wife and I were at a restaurant called Garden House (the building is still there, but it hasn't been a restaurant in many years). I'm not sure how we did it, but we were without our kids who were 8 and 5 at the time (woo-hoo). We got to talking to the couple at the next table. He was a new professor at SUU (this was his last stop, he retired a few years ago). Anyway, they had come from FGCU near Fort Myers. That area of southwestern Florida was one of the first places where the bubble collapsed hard and fast. They remarked that they were glad to get out of there, and had lost a lot of money selling their house. I was shocked and surprised. The housing bubble was not yet on my radar screen, although I'd noticed that appreciation in my neighborhood on Leigh Hill had stopped. The date? August of 2007 ... about a year before the financial crisis got really bad.
Second, a better connected SUU faculty member who does a lot more consulting used to occasionally farm some work out to me. He passed some spreadsheets to me, and wondered what we could do with it. It was from a very large international bank. And they were worried that before, people had gotten behind on their mortgages and then recovered, and now they weren't: people were slipping from 30 days behind, to 60, to 90, and so on, without showing any improvement. This bank was worried about having these assets on its balance sheet, and wanted better forecasts of this data. The consulting job was competitive, and really before we could put much together the bank told us they were going in a different direction. It happens. The date? December 2006, a little less than 2 years before the financial crisis got really bad.
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