Senior Fellow Kevin A. Hassett

Turn on a cable-news channel and listen to an economics discussion, and you get the distinct impression that housing activity in the U.S. has just gone through an unprecedented and irrational boom. The morality tale is cited as proof that markets do not work, and that new and intrusive government regulation is needed.

A look at the data, however, tells a markedly different story.

The accompanying chart relates real investment in housing by U.S. households to real GDP from 1952 until this year. The chart reveals that housing investment has been volatile throughout the past half-century. By the standards of past booms and busts, the current episode looks tame. By this measure, the boom was not nearly as high as past indiscretions, and the bust has already reversed it.

Indeed, a simple, rational, free-market story explains the current housing mess. The Federal Reserve kept interest rates very low as the economy recovered slowly from the last recession. Those low rates boosted housing activity. When rates were lifted as the economy finally took off, housing activity fell back.

Simple and straightforward economics explains price movements as well. When interest rates were very low, buyers flocked into the housing market looking for homes. All of that extra demand drove up prices of the existing housing stock. Home builders responded to the higher prices by building new homes. When enough of those were finished, it put downward pressure on prices because of the increase in supply.

Of course, there have been excesses. But the market is dealing well with them. Those who made imprudent loans have lost a lot of money, and will not be around to lend again the next time the housing market takes off. Prudent lenders will survive, and will finance the next takeoff, which, the data suggest, might not be that far away.

Kevin A. Hassett is a senior fellow and director of economic policy studies at AEI.