Understanding Housing Bubbles
Understanding Housing Bubbles
Co author Demographia International Housing Affordability Survey
Demographia
August 10, 2008
The Press
(Christchurch, New Zealand) article Leaky homes and the
housing It would appear that this is because of
their training - and the influence of Professor Paul
Samuelson (Economics 101), as outlined by Mark Skousen's The
"There is in academic economic theory a growing unease,
an unease that the entire approach of the field may be in
error. This unease is reflected in the growing criticism of
the prevailing method of 'doing' academic economics - the
great emphasis placed on complex and difficult mathematical
formulas to express economic activity. Paul Samuelson is
still perhaps the pre-eminent representative of the
contemporary approach in academic economic theory. Is
Samuelson's mathematical method of presenting economic
theory of value, or should it be placed on the trash heap of
history?
There is a difference between intelligence and
relevance of intellectual academic output. The most
brilliant individuals - individuals whose intelligence far
outstrips the rest of us - can be completely wrong in their
factual appraisals of the world....In short, Samuelson is a
great mathematician, but he knows little about economic
activity. He does not understand how the market
works." The 5th through 11th Editions of Samuelson's
standard textbook "Economics 101" incorporated a graph
showing that economic growth in the Soviet Union was
catching up on the United States. The 1988 12th Edition
provided a table declaring that between 1928 and 1983, the
Soviet Union had grown at a remarkable 4.9% annual growth
rate, illustrating that GDP per capita would soon surpass
that of the United States. The Soviet Union and communism
collapsed within 12 months. It was subsequently learnt that
the Soviet Unions GDP was smaller than that of the
Netherlands. Just another serious Samuelson blunder - one
that should have sent shock waves through the profession of
economics 20 years ago. Within the above article "Leaky
homes and the housing bubble" - Neville Bennett, a retired
lecturer of Canterbury University and Cameron Bagrie, an
economist with ANZ National Bank New Zealand, make no
reference whatsoever to the structural drivers of the
housing market. They choose instead to mention peripheral
matters - such as immigration and unsophisticated investors.
Bagrie - it would appear - is "confused" why increased
interest rates by the Reserve Bank did not dampen
speculative activity (who cares about a 25 basis point rise
in the OCR if one is making 100% a year by debt loading and
flicking property). The Annual
Should housing prices exceed three times annual
household incomes - this is proof that there is some
structural impediment to the supply of affordable
housing. These matters are further explained within the
writers' paper Getting
It would appear too
- that there is an urgent need for retraining of economists
and property appraisers / valuers with respect to the
difference between "inflation" and "growth". As part of this
retraining - the important differences between a "boom" and
a "bubble" need to be taught as well. Urban housing
bubbles cannot form - if affordable new supply is allowed to
meet increased demand. Just like computers, cars and any
other household item. If affordable new supply is impeded
as demand "kicks in" - this "scarcity" triggers inflated
prices (fake value) - a bubble. There are three phases to
an urban housing bubble - firstly, a ramping up of prices -
secondly, a plateau - and thirdly a collapse, as fake value
is wrung out of the system. All urban housing bubbles behave
slightly differently - depending on the intensities of
demand and supply. The 1990 Japanese bubble collapse and
current Californian one - are excellent "real life"
lessons. During the ramping up of a bubble, both lenders
and purchasers convince themselves that prices will inflate
forever and normal market risks are ignored (a speculative
frenzy and phony boom). Lending institutions discard "cash
flow based lending" and instead engage in "inflation based
lending". They are essentially forced to - to maintain
market share. Both parties convince themselves that in the
event of default, they will be able to sell the property at
a higher inflated price. So "losses' are a thing of the
past. As the bubble nears a "plateau" - where all parties
become anxious about the inflated prices and household
incomes become more stressed with excessive debt loads and
defaults - both purchasers and lenders realize there will no
longer be any inflation to protect them. During the
"plateau phase" - lenders become increasingly nervous,
knowing that the protection of inflation is no longer there
for "inflation based lending" and suddenly revert back to
"income based lending". Sales volumes then fall - as the
supply of "easy finance" dries up and property owners
attempt to hold prices at inflated values. Eventually the
third phase is reached - as property owners can no longer
"hold out" and purchasers and their lenders become
increasingly unwilling to pay "fake values" (above three
times household incomes). While the finance sector was
happy to privatize the profits during the upside of the
bubble, its focus through the collapse - is to socialize the
losses - by pleading for government / taxpayer welfare, as
fake value is wiped out. Too often builders and real estate
interests (note the US NAR and NAHB advocacy) actively plead
for taxpayer welfare as well, in a vain and "money wasting"
endeavor to prop up the fake value of bubbles. This simply
distracts policymakers from dealing with the real structural
issues. Governments at National, States and Local level
already have enough problems of their own in these bubble
markets (having created them in the first place) - as they
have been proliferate spenders during the upside of the
bubble - only to find that their revenues fall through the
downside. Again - California is an excellent "real life"
lesson in this regard. Others will inevitably follow. The
current global housing bubbles are unprecedented with
respect to their intensity and scale - and their scope for
creating substantial political, social and economic
disruption. When these massive and indeed unnecessary
"disruption costs" become more obvious - and most
importantly experienced - regrettably the economics
profession will not likely have the necessary skills to
assist in working through "real life" solutions - to ensure
that urban housing bubbles do not get underway again.
Economists urgently need to start living in the real world -
by focusing on the structural urban issues. This
explains why people from the planning world - such as
Professor Shlomo
ENDS
Unfortunately
Bagrie and Bennett make no mention of the relevance of
"scarcity" in the formation of urban housing bubbles and
fail to explain why the urban markets - for example - high
growth (in population and economic activity terms) - of
Houston, Dallas Fort Worth and Atlanta did not create
housing bubbles. Yet Los Angeles inflated to 11.5 time's
household earnings (currently collapsing - with Sydney
Australia now being the worst in the Anglo world - refer
Sydney