Was There a Housing Bubble?

I wish that Alex Tabarrok would pass the bottle over here. He’s got a very interesting graph illustrating real housing prices for the last 120 years (go over there to see the graph). Here’s his observation:

The clear implication of the chart is that normal prices are around an index value of 110, the value that reigned for nearly fifty years (circa 1950-1997). So if the massive run-up in house prices since 1997 was a bubble and if the bubble has now been popped we should see a massive drop in prices.

But what has actually happened? House prices have certainly stopped increasing and they have dropped but they have not dropped to anywhere near the historic average (see chart in the extension). Since the peak in the second quarter of 2006 prices have dropped by about 5% at the national level (third quarter 2007). Prices have fallen more in the hottest markets but the run-up was much larger in those markets as well.

Prices will probably drop some more but personally I don’t expect to ever again see index values around 110. Do you? If we don’t see the massive drop back to “normal” levels then the run up in prices should be described as a shift to a new equilibrium – much as happened during World War II – see the chart. (It’s an important question to ask what changed and why?). In the shift to the new equilibrium there was some mild overshooting, especially due to the subprime over expansion, but fundamentally there was no housing bubble.

Or, alternatively, house prices aren’t perfectly elastic.

Here are the factors that I think are contributing to what we’re seeing:

1. The run-up in prices came after an enormous amount of money was made in the tech bubble of the late 90’s.
2. Stocks have been lacklustre since then.
3. There was a lot of money sitting around with no place to go.
4. Some of it went into speculative real estate purchases.
5. Creative financing contributed to the spike.
6. Some of the creative financing was a little too creative.
7. There’s still no where for the money to go.

Perhaps there are some investors out there hoping that the whole thing will just blow over. I doubt that will happen soon, especially on the costs where the biggest runup in prices has occurred. So, in answer to Alex’s question, yes, I do expect that housing prices have a lot more to give.