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Tuesday, January 11, 2005

Housing Prices: An asset bubble?

by Calculated Risk on 1/11/2005 11:18:00 PM

Here is a look at the period from Jan 1998 until Dec 2004. I chose this period since this is when it appears housing prices accelerated.

NOTE: I'm posting this now and will update the post when new data for 2004 becomes available. Over the first 9 months of 2004 housing prices increased 8.9% while Household income was stagnate. So any bubble at the end of '03 will be larger now.

1) Home prices increased 49% nationwide during the 6 year period.
SOURCE HPI: OFHEO

2) Although real household incomes have been stagnate, with inflation household incomes have increased 17% from ’98 to ’04.
SOURCE: Census Bureau

3) Mortgage rates (30 year fixed) declined from 6.99% in Jan 1998 to 5.88% in Jan 2004.
SOURCE: FreddieMac

The drop in interest rates would predict a 19% increase in potential debt to keep the buyer’s monthly payment the same. However taxes would have also increase based on the value of the home. Therefore, a simple model would have predicted a 15% increase in prices due to changes in interest rates and taxes, and 17% due to increases in household incomes (because of inflation). Taking the multiple, the model would have predicted an increase of 34.5%, instead of the 49% increase we have observed.

This would argue (if ’98 prices were reasonable) that home prices are approximately 14% overvalued due to speculation or easy terms (ARMs, 0% down, etc). If mortgage interest rates increase, or we have a recession (lower household income), home prices would be even more overvalued.

A similar analysis was performed by the FRBNY Economic Policy Review, Dec 2004 "Are Home Prices the Next Bubble?"
Their conclusion: "The marked upturn in home prices is largely attributable to strong market fundamentals: Home prices have essentially moved in line with increases in family income and declines in nominal mortgage interest rates."

More to come ...