Why the housing bulls never made much sense
Kristopher Gerardi, Christopher Foote, and Paul Willen, of various regional Federal Reserve banks, have a paper which looks at economic research on whether or not there was a housing bubble, and which concludes that “we do not currently have the ability to prevent a bubble from forming or the ability to identify a bubble in real time”. Yes, they admit, some smart and prescient economists did say, with complete accuracy, that there was a bubble. But! Other economists weren’t convinced! So, never mind, there’s nothing we can do.
Tracy Alloway has already dealt with the part of the paper which looks at the housing bears, but for me the part looking at the housing bulls is far more interesting. The paper says that “there were reasonable arguments on both sides” — so what were these reasonable arguments saying that there wasn’t a housing bubble? It turns out that they’re pretty laughable.
The main argument of the housing bulls is also one of the silliest:
If housing was so obviously overvalued, as the pessimists suggested, then investors stood to make huge profits by betting against housing. By doing so, investors would have ensured that house prices would have fallen immediately.
This doesn’t even pass the laugh test. For one thing, there’s an enormous difference between being able to identify a bubble, on the one hand, and being able to profit by betting on it bursting, on the other. Look at stock-market bubbles, which are easy to short: unless you know when they’re going to burst, it’s very hard to make money and very easy to lose money by betting against them. And of course no one knows when any bubble will burst.
But applying this argument to housing bubble makes even less sense, because it’s almost impossible to bet against housing. You might be able to short proxies for the housing market, like real-estate investment trusts or homebuilding stocks. But you can’t short houses themselves. And the handful of people who did manage to make money by shorting the housing market only managed to do so after Wall Street spent a huge amount of time, effort, and money creating credit default swaps on collateralized debt obligations comprising a large number of thin slices of private-label subprime mortgages. Such things didn’t even exist for most of the housing bubble, and even after they were invented they were available only to a very small number of dedicated housing bears.
The paper also quotes what it calls “perhaps the most widely cited evidence against a housing bubble” — a 2005 paper by Himmelberg, Mayer, and Sinai — as saying that “expectations of outsized capital gains appear to play, at best, a very small role in single-family house prices”. That argument is echoed in another paper, by John Quigley, who “claimed that high transactions costs in housing markets would tend to decrease the amount of speculation”.
This is also a silly argument, and it seemed silly at the time: you don’t need speculators to have a housing bubble, and indeed many of us were pretty clear that a large chunk of the housing bubble was not speculative.
On the other hand, it’s downright idiotic to look at rampant house-price appreciation and use it as evidence that there isn’t a housing bubble. But yes, even that argument was trotted out, as part of the thesis that houses weren’t overpriced if you look at the total cost of housing. Get a load of this:
The argument here is that the cost of housing is low, so there isn’t a bubble: houses are priced in line with fundamentals. But a key part of those “fundamentals” is the rate at which house prices are rising! In other words, the faster that house prices are rising, the cheaper houses look. Crazy.
Similarly, other housing bulls looked at “hedonic indices” and the size of homes, concluding that “a significant portion of the house price appreciation measured using the median price and repeat-sales indices was attributable to quality increases” — and therefore that there wasn’t a bubble. But the fact is that if a million-dollar house is unaffordable, it makes no difference how big it is, or how high its quality is. (And I haven’t found anybody saying that the quality of housing stock rose during the bubble in any respect other than sheer square footage.) If house prices are at unsustainable levels, then they will drop, regardless of how many square feet they’re based on.
So my conclusion, after reading the arguments of the housing bulls, is that they were mostly bunk. And there’s even a hint of that in one of the footnotes to the paper, which says that “economists at policy institutions may have shied away from making pessimistic predictions for fear of spooking the markets”. It seems to me that if there wasn’t a bubble, no one was likely to be worried about spooking healthy rising markets.
The bigger conclusion, of course, is that it’s silly to look to economists to forecast anything at all. Not because they don’t have the tools, but just because it’s always possible to find an economist who’ll believe just about anything. Housing bubbles are normally pretty obvious at the time: there’s one right now in Vancouver, for instance. You can see them in the rise of dozens of huge new glass-clad condo buildings; you can see them in massive price increases; you can see them when mortgage payments are significantly larger than the amount of money you could get renting out the place; and you can see them whenever people start making more money from selling their homes than they do from actually working. The only people who can’t see them, it seems, are economists, realtors, and bankers on Wall Street.