Fed Rethinks Stance on Popping Bubbles (October 17)
Dear Mr. Lahart (The Wall Street Journal):
A very useful article. You are right that identifying bubbles is difficult. However, this is hardly the case with the housing market. The bubble was obvious and completely predictable.
We have (at least) six decades of good data on the relationship between household incomes and housing prices. The historic norm has generally been 3 --- a median price at 3 or fewer times that of median household incomes. That ratio was greatly exceeded --- for the first time --- over the past decade. Moreover, its increase was very geographically focused. As Paul Krugman has pointed out... there was not housing bubble in much of the country. If the Fed and others had bothered to look at the geographical distribution of the bubble and then asked questions about why, the answer would have been very obvious. Areas with very strong land use regulation were unable to accomodate the increased demand, and the regulation constrained supply worked to explode housing prices --- a tripling of the ratio for example in the Los Angeles area and at least a doubling in most of the other highly regulated markets. Meanwhile, where the more traditional, liberal land use regulation that had characterized virtually all parts of the country until about 20 years ago, there was little change in the ratio. These markets include Atlanta, Dallas-Fort Worth, and Houston, which are the three fastest growing metropolitan areas over 5m population in the developed world.
It is not as if people were not watching the inflating bubble. Real estate and market analysts were falling all over themselves, cheerleading the "performance" of the housing market. tt should have been obvious. One of the lessons of this affair is that to simply look at the economy (or specifically the housing market) from a macro-economic perspective is not enough. All of this could have been predicted (and perhaps avoided) if those whose job it is to encourage economic stability had simply been watching.
We have dealt with these issues in four annual editions of the "Demographia International Housing Affordabilty Survey," the fifth edition of which will be published early in 2009. The current edition is available at http://www.demographia.com/dhi.pdf.
Co-Author, Demographia International Housing Affordabiltiy Survey
Principal, Demographia (St. Louis)
Visiting Professor, Conservatoire National des Arts et Metiers (Paris)