Almost everyone understands that the 2007-8 financial crisis was precipitated by the collapse of a huge housing bubble. The Obama administration’s remedy of choice was the Dodd-Frank Act. It is the most restrictive financial regulation since the Great Depression — but it won’t prevent another housing bubble.
Housing bubbles are measured by comparing current prices to a reliable index of housing prices. Fortunately, we have one. The United States Bureau of Labor Statistics has been keeping track of the costs of renting a residence since at least 1983; its index shows a steady rise of about 3 percent a year over this 30-year period. This is as it should be; other things being equal, rentals should track the inflation rate. Home prices should do the same. If prices rise much above the rental rate, families theoretically would begin to rent, not buy.
Housing bubbles, then, become visible — and can legitimately be called bubbles — when housing prices diverge significantly from rents.
In 1997, housing prices began to diverge substantially from rental costs. Between 1997 and 2002, the average compound rate of growth in housing prices was 6 percent, exceeding the average compound growth rate in rentals of 3.34 percent. This, incidentally, contradicts the widely held idea that the last housing bubble was caused by the Federal Reserve’s monetary policy. Between 1997 and 2000, the Fed raised interest rates, and they stayed relatively high until almost 2002 with no apparent effect on the bubble, which continued to maintain an average compound growth rate of 6 percent until 2007, when it collapsed.
Today, after the financial crisis, the recession and the slow recovery, the bubble is beginning to grow again. Between 2011 and the third quarter of 2013, housing prices grew by 5.83 percent, again exceeding the increase in rental costs, which was 2 percent.
Many commentators will attribute this phenomenon to the Fed’s low interest rates. Maybe so; maybe not. Recall that the Fed’s monetary policy was blamed for the earlier bubble’s growth between 1997 and 2002, even though the Fed raised interest rates during most of that period.
Both this bubble and the last one were caused by the government’s housing policies, which made it possible for many people to purchase homes with very little or no money down. In 1992, Congress adopted what were called “affordable housing” goals for Fannie Mae and Freddie Mac, which are huge government-backed firms that buy mortgages from banks and other lenders. Then, as now, they were the dominant players in the residential mortgage markets. The goals required Fannie and Freddie to buy an increasing quota of mortgages made to borrowers who were at or below the median income where they lived.
Senior Director, Coldwell Banker New Homes Division
With over 200 condominium, townhome and loft projects successfully marketed
“Fewer properties for sale with such remarkably low interest rates make it a great time to sell but a more difficult time to buy”