By Dean Baker
Recent data showing housing prices rising at their fastest rate since the collapse of the bubble have many people asking whether we are seeing another bubble. That is a good question.
At the national level the answer would almost certainly be "no." Different indexes show slightly different stories, but inflation adjusted house prices nationwide are still down by roughly a third from their bubble peaks. This means that house prices may be slightly above their long-term trend level, but close enough that no one could say they are out of line with the fundamentals of the housing market. That doesn’t mean that there can’t be a dip, but there is no reason to expect another plunge like the 2007-2009 collapse that threw us into recession.
Cause for concern
While house prices nationally may not be out of line with fundamentals, there are serious grounds for concern in many local markets. House prices have been rising at an extraordinary pace in many markets and may soon be hitting levels that are clearly unsustainable.
The fastest rate of price increases can be found in many of the former bubble markets. Cities like Phoenix, Arizona and Las Vegas, Nevada are seeing very rapid rates of price increase, as are many of the cities in the central valley in California. Prices in many of these cities have risen by more than 20 percent over the last year.
Furthermore the most rapid price increases are occurring at the lower end of the market. In Las Vegas the price of homes in the bottom third of the market have risen by more than 40 percent over the last year. In the last three months they have increased at almost a 70 percent annual rate.
There is a similar story in Phoenix where prices for homes in the bottom third of the market rose by just under 40 percent over the last year and have risen at just under a 50 percent annual rate over the last three months. Many neighborhoods in California cities like Modesto or Vallejo are experiencing the same sorts of run-ups in price.
These markets were all badly beaten up in the crash with prices falling back to levels not seen since the mid-90s. As a result, current prices in these markets are not obviously out of line with fundamentals.
However the concern is if these rates of increase continue. If a market is properly priced today, but follows the same path as the bottom tier of the Phoenix market and rises 50 percent over the next year, then it will be seriously overvalued in another year. Even worse, if one of these markets were to sustain the 70 percent rate of increase recently seen in the bottom tier of the Las Vegas market over the next year, then we could be looking at a market that is 70 percent overvalued.
Investors are driving prices in the markets seeing the rapid run-ups. In many cases, hedge funds and private equity investors are buying up large blocks of houses. Some may plan to rent them out for a period of time, but most undoubtedly expect to flip them for substantial profits in the near future. Similarly, many smaller investors are buying up homes, doing minor repairs, and then looking to resell them for a substantial profit a few months later, just as they did in the bubble days.
The problem with these investor purchased homes is that the process only makes sense as long as prices continue to rise. There are no great windfalls for people buying homes and flipping them in a stagnant housing market.
If the hedge funds and flippers end up taking a hit when the music stops no one could be too upset. Presumably they understood the risks when they got into the market.
The real problem is that many ordinary homeowners may get caught in the middle just as they did in the last bubble. If these markets go into bubble territory and then prices fall back by 20-30 percent new homebuyers will have seen their equity disappear and find themselves underwater, just as happened in 2008-2010.
While people have to make up their own minds on whether homeownership makes sense for them, it would be good if the government and non-profit sector made the push against homeownership this time if these markets go back into bubble territory. There are many advantages to homeownership, but that’s not the case when it comes to buying a home in a bubble market. No one builds assets by paying 30 percent too much for a house.
Many low and moderate income people saw their dreams destroyed when the last bubble collapsed. It would be too cruel to see the same mistake repeated just a few years later.
Dean Baker is an economist and co-director of the Center for Economic and Policy Research. He has written extensively on a wide range of topics, including the housing bubble. His most recent book is The End of Loser Liberalism: Making Markets Progressive (free download available here).