Misconception 3 – Easy credit caused the housing boom

This one is more an oversimplification than a misconception.

There have been very similar credit conditions across all housing markets in the US. However vast differences in changes in price by city/ region. So while easy credit conditions during the boom certainly had a significant impact they are only one part the whole story. The economic literature and my 5 years experience studying speculative forces in housing markets suggest the following factors.
- Local economic growth rates
- Housing supply restrictions
- Expectations based on local past experience

Economic growth rates (and the associated changes in wages, economic migration, employment etc) make a significant difference in the demand for housing. We can see this most dramatically in looking at house price figures for a city like Detroit where house prices have been decreasing in real terms for many years due to a decline in their traditional industries and a subsequent migration out of the city. Fundamental economic factors are likely to have been at work to early in the booms in growth areas in the Sunbelt.

Supply restrictions on land and building are also likely to have resulted in the inability of the market to quickly supply relatively affordable housing and stop prices from increasing quickly as demand increased. See http://www.demographia.com/dhi.pdf for a detailed international perspective. This study shows booms in prices across hundreds of cities worldwide overwhelmingly occurred only in cities with relatively tight planning restrictions.

Studies of what investors and home buyers expect to happen to house prices in a particular housing market indicate that most people project recent past prices changes (over the past year or two) into the foreseeable future. So once prices begin to discernibly rise potential buyers scramble to buy quickly before prices rise further. They are willing to buy at prices greater than similar homes have recently sold for as they believe prices will be higher still in the future. Without this factor house prices will generally appreciate only slowly as buyers and sellers are looking at prices of similar properties in deciding a reasonable price to buy and sell. Once prices stop rising potential buyers stop believing that prices are going to continue to rise in the short term and the bust begins.

How can this knowledge help policy makers? Clearly once a boom has run it is largely to late for policy makers to contain damage such as:
- builders having built houses that people do not want to buy
- investors/home owners financially overstretched
- banks and others find their loans are not being repaid and the loan is worth more than the collateral

1. As booms are local phenomenon the use of broad nationwide monetary instruments (e.g. interest rates) or fiscal policies (e.g. incentives to homeowners/builders) is not advisable.

2. Supply side restrictions need to be decreased as much as possible so affordable housing enters the market in a timely manner.

3. Decrease unrealistic expectations about future house prices. This requires the provision of strong public education through all available channels to dampen down unwarranted speculation based on unrealistic expectations. Channels could include media, industry groups, investment advisers etc. Furthermore a government pre commitment to take credible actions to decrease prices in speculative bubbles would send a message that the boom will swiftly end and make the educational message more credible. Such commitment could include temporarily increased taxes on capital gains from housing, or swift decreases in restrictions on supply in the case of increased prices.

4. However, perhaps the most effective deterrent to future housing bubbles is simply to let this bubble deflate without the kind of support which will stop prices from returning to more realistic and normal levels. House prices in many markets are still far above pre boom levels and well above historical levels when compared with incomes or rents. To stop house prices from returning to economically sustainable levels would be:

- expensive

- unfair to those who have not benefited from the previous boom and

- counter productive; as without expensive and ongoing artificial support prices will still fall at a later date and the lessons of the boom and bust would not have been learnt thoroughly enough to prevent a repeat.

How can this knowledge help homeowner and investors?

1. If you live/own in a market that has had a large boom and have equity in your home and selling is an option you would consider then it's probably better to sell now then wait for a few years and sell at lower prices. this is particularly so if you currently have some equity in your home but might be forced into foreclosure (and hence loose all your equity in the house) at a later date.

2. If you're renting and looking to buy in a city that has boomed and boom prices are well above what they were before the boom began then there is no hurry as houses will probably be significantly cheaper in the coming years.

3. If in the future you see people making a lot of money by investing in housing (or anything else) during a boom time - don't be panicked into buying or think this is the way to make easy money . The boom will end and those that made a lot of money will probably loose a lot of money. In the long term the price of housing will remain in line with rents and prices. We don't' know who long it will take this to happen -sometimes prices zoom back down in two years and sometimes it takes 15 years of house prices standing still while inflation and increases in real wages catch up.

For an excellent source of both insight and data from an international perceptive see http://www.jensks.com/