Monday, May 17, 2010

Building Is Booming in a City of Empty Houses

New York Times article "Building Is Booming in a City of Empty Houses" (May 15th, 2010) suggests that the country has too many houses. While it gives some reasoning for this argument, the evidence for a bubble is not clear-cut to Corrections.

Simply put, the country already has too many houses, the legacy of wide-scale overbuilding during the boom. The Census Bureau says there are two million vacant homes for sale, about double the historical level. Fewer new households, moreover, are being formed as families double up for economic reasons, putting a further brake on demand.

Was there a housing bubble in prices? Was there a housing bubble in construction? One might ask, as Casey Mulligan has (our analysis is indebted to him), whether or not these oft-cited bubbles are really bubbles--the answer is not immediately apparent to Corrections. There does not appear to have been a particularly spectacular housing boom in terms of new housing units or housing completion, judging from the biannual American Housing Survey. The housing bubble is often cited to have started in 1996, when the Case-Shiller Housing Index first began to rise dramatically. However, it appears as though half of the dramatic rise in prices from 1996 has survived the "bubble's" burst--indicating that at least some portion of the bubble was not a bubble at all, but driven by some fundamentals. Housing Units from the American Housing Survey are displayed below, along with the composite Case-Shiller Index, Housing Completions from the Census, and Residential Investment from the Bureau of Economic Analysis's National Economic Accounts (click to enlarge). Housing Units for 2009 is due Summer 2010--the value displayed is imputed from housing completions over a period of 20 years, and some interstitial data points are similarly linearly imputed. An update will be offered when the American Housing Survey for 2009 is released Summer 2010.

As one can see, the stock of housing units never increased dramatically--15% at their peak. The flow of housing completions and residential investment both grew and have fallen from their peak. However, prices have not fallen completely, which indicates to Corrections that the "bubble" was not necessarily a bubble, but simply a housing boom, driven at least in some part by fundamentals--were it not, prices would be even lower than they are now, given an increased housing stock.


  1. I see that corrections is differentiating between 'bubble' and 'boom'. In common financial media (WSJ, FT, Economist), however, 'bubble/burst' and 'boom/bust' are used synonymously, no?

  2. Corrections does not often use either term--both are the terminology of at least two brands of economics we either don't understand or don't care for. But we expect every economist has terminology for large expansions that last--what we call booms, that do not have to be followed by "busts."

    A bubble, to Corrections, is a rise in price that is not driven by rational expectations of market fundamentals. In asset theory, it would be a violation of the transversality condition--some sort of irrational exuberance.

    To distinguish the two, we would suggest that a boom could simply be due to rational expectations. Imagine a world in which there is a 50/50 chance that demand will double some time in the future. Then it could make sense to dramatically increase factory investment. Were the demand not to materialize, it would be silly to call this a "bubble"--it was due to perfectly rational investment.

    The region between the two is not demarcated clearly (difficult to distinguish empirically), but the theory behind the two is entirely different.

    For Corrections, a boom can be perfectly rational and be an optimal solution, even if a bust follows. Further, busts do not have to necessarily follow booms. A bubble is due to "irrational exuberance" or violations of transversality conditions for asset price expectations.

    That the two are used synonymously in the financial media would be part of our criticism of the financial media--we see this as perhaps a boom, not a bubble--rational or driven by fundamentals, rather than "irrational exuberance."

  3. Point well taken. Thank you for the follow-up.

  4. Perhaps. But one could look at it another way. Using the term boom in the same spirit as a reaction to the expectation of market fundamentals - or perhaps as an event reflective of some new fundamental driver of productivity (the industrial revolution, electricity, the computer etc) it does make sense to distinguish from a bubble separate from rational market expectations. But there is an additional factor. When governments manufacture vast amounts of additional money/credit (as the Fed has done with some exuberance and variability since the mid-1990s and continues to do so) there is essentially a flood of money that has to go somewhere. One could suspect that the massive inflow of capital seeking return contributed to the dotcom boom and the housing boom - the former particularly attractive because the hype led to impossible expectations or reward (that seem quite comic in retrospect) and the latter because of the assumption of low risk given a long period of growth of housing prices and the moral hazard inherent in various regulatory and legislative drivers of the market and politically empowered and utterly irresponsible agencies like FannieMae and FreddieMac. The end results was that "fundamentals", the demand for housing increased, but ultimately the drivers - politics and cheap credit - were unsustainable.