STAFF NEWS & ANALYSIS
What Happens After the Housing Bubble Reflates?
By Staff News & Analysis - March 27, 2013

The Housing Bubble Is Back … Cullen Roche is worried that the trajectory of housing prices might deviate from what practical assumptions would predict " Real estate returns are not rocket science. Because they're such a huge portion of the consumer balance sheet they tend to be tied very closely to wage growth. Wage growth, by definition, is very closely tied to the rate of inflation. That explains why the long-term historical return of real estate is roughly in-line with the rate of inflation. But this survey from Zillow shows that real estate 'investors' are probably still too optimistic." − Forbes

Dominant Social Theme: Housing prices are coming back, thanks goodness.

Free-Market Analysis: This Forbes analysis is actually a fairly sophisticated analysis on how realtors decide whether houses are a good buy or not. The article concludes that houses may be cheap to buy given current conditions. And this, apparently, may begin to drive a housing bubble once more.

Now, the larger question begins to percolate: Are houses cheap because of fundamental economic factors or for monetary reasons? After all, if central banks print lots of money – as they have been – then people are making more money.

The result is that wages are up while house prices have not yet begun to catch up. Wages drive rents upward and rents drive housing prices. Here's more from the article:

It looks like under [a] baseline assumption, it's cheaper to buy than to rent in every one of the top 100 metropolitan areas in the United States. In traditional hotspots like the San Francisco Bay area, New York City and Orange County, CA, the discount is low. Still this is a recipe for fundamentals house price appreciation.

If housing prices merely stabilized into a sustainable equilibrium with rents then the future probably wouldn't be too dramatic. We would see a rapid shoot-up in home prices now, followed by a long period of little to no price growth as the Fed raised interest rates.

… However, there is an ever increasing chance that this is not the future we are facing. Some time in the near future it is very likely that credit standards for homebuyers will fall. This will allow homebuyers to make larger offers and it will allow young people to buy a home even when they lack a down payment.

This rapid increase in the number of buyers and their purchasing power will likely drive home prices into a bubble. Likely not as large as 2005, but it's not out of the question that the bubble could be even larger.

We might think – "didn't lenders learn their lesson?" Or perhaps, "see this is what we get when we create moral hazard."

… If a lender tries to play it safe then she will still get screwed by the fact that any loan she makes will be to a buyer who is paying market price, which is bubble inflated. Yet, she will be doubly screwed by the fact that she is losing market share and thus not even making a lot of money on the upside of the bubble.

So she is pushed to lower standards as well.

This is amplified by the fact that the actual consequences she faces as a decision maker will be harsher the more atypical her choices are. If she goes with the flow she probably will not be punished when everything goes bad. If she refuses to go along with the flow then she will be punished for making low returns while everyone else is profiting from the bubble.

Given all of that it will be very hard for her to resist the pressure to lower standards. Hence, we should predict that a competitive market will see standards go down.

As standards go down, buyers rush in with more buying power and we enter a new bubble phase. To my knowledge neither the government, the lending industry nor we as a society have done anything that promises to prevent this.

Let's be blunt: Despite its apparent sophistication, this kind of analysis is irritating on several levels. Leaving aside the political correctness of using "she" instead of "he," the article is determinedly presenting the idea, ultimately, that it is the diminishment of lending standards that drives a housing bubble.

Hooey, we say. What drives bubbles of all kinds is the overprinting of money and the lengthy relaxation of interest rates. This does indeed drive up wages over time and makes people feel rich. The analysis we are exposed to in this article neglects to point out WHY wages are rising.

Wages are rising because the Federal Reserve is flooding the US economy with currency. Over US$100 billion a month, apparently.

To date, the money printing has not lifted the larger economy of the US, though it certainly has affected certain industry sectors. Lawyers are likely starting to receive large fees again and those who work in the financial sector and certainly in banking may be feeling increasingly wealthy, at least some of them.

It is just the beginning, of course. We fully expect a good deal of price inflation in Western economies as a result of the trillions that have been stuffed into banks and that are starting to circulate. The difference this time is that the US itself is deeply in hock and the Fed is thus constrained from raising interest rates without destroying the annual resources of the federal government.

After Thoughts

There will surely be a housing bubble given the rashness of central banking actions. Whether the dollar itself will survive upcoming monetary events is the larger – and even more serious – question.

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