House prices continue to rise. Yesterday a Bloomberg article reported that home prices jumped to all-time highs in almost two-thirds of U.S. cities in the fourth quarter in the face of limited new supply and an improving job market. Rising home prices have spurred the question: Are we in another housing bubble?
Our quick answer is probably not, but prices are elevated. We constructed a chart of the relationship between median home prices and median household income going back to 1987. We used national numbers, including the S&P/Case Shiller U.S. National Home Price Index and Median National Income. Since the home price index isn’t adjusted for inflation, we used nominal household income.
We went back as far as we could using data on the St. Louis Fed website – 1987 — and we found that for the period up until 2000 the index stayed around 100. And that’s what you’d expect because prices shouldn’t get radically divorced from income. But then a sharp rise ensued peaking at a whopping 153 in 2006. That was the bubble. We’re at 120 now, which is where the index was in the 2003-2004 period. The standard deviation of the data set is 16. So, at 120, we are beyond it using the early 1990s flat period average. But we are not at two standard deviations (which some people use as the definition of a bubble) from that early flat period.
Our chart doesn’t capture the differences in regions and cities. Home prices on the coasts, for example, may be extravagant again. Indeed the Bloomberg article reports that the most expensive markets were San Jose, San Francisco, Irvine, Honolulu, and San Diego, with San Jose experiencing a whopping 26% increase in prices. So some cities might be in bubble territory, but the relative simplicity of our approach indicates where the national market stands compared to the bubble, and also gives a somewhat longer term perspective. A crash in San Jose and other California cities probably wouldn’t affect the entire country or banking system the way the previous housing crisis did, though it could lead to a recession.
Anecdotally, mortgages aren’t as easy to get as they were during the run-up to the bubble. We’ve heard stories from well-qualified borrowers whom banks have assessed with considerable rigor. Still, it’s likely that very low interest rates have spurred the new price increases. Mortgages may not as easy to get for most people, but they are still available. And because enough of them are still available and rates are so low, house prices continue to levitate.
It’s important to note, however, that there isn’t always a strictly mechanical relationship between interest rates and asset prices. Economist Robert Shiller, who is a student of asset price bubbles, rarely mentions interest rates as primary causes of bubbles, and he’s quick to point out that there have been periods of low rates and low asset prices such as in the 1940s. There are always psychological factors involved when prices elevate beyond reason. Still, nobody should ignore low rates. It’s likely that low rates have facilitated the new rise in home prices as well as other asset prices.
The psychological factors are harder to assess. People aren’t flipping condos for sport the way they were during the bubble when mortgages were available to anyone regardless of whether they had income or assets. Yet t seems there’s a widespread desire to own assets – stocks, bonds, and real estate – regardless of price. It’s not an obviously happy mania, where people are motivated by promises of great wealth. It’s more like a need to be an asset owner in an economy that continues to hurt workers without college degrees and becomes more automated. Nevertheless, the price insensitivity of many buyers is enough to cause concern.