Here we go again?

Shutterstock.com

Article Highlights

  • The unsustainable house prices collapsed starting in 2007 and continued to fall until 2012.

    Tweet This

  • In the long run, there is a very close correlation between general inflation and house prices.

    Tweet This

  • There is also a very close long-run correlation between house rents and house prices.

    Tweet This

There is no doubt in anybody’s mind, since we can see it with utter clarity in retrospect, that the Great U.S. Housing Bubble of 1999-2006 drove house prices far above their sustainable trend.  Based on those bubble prices, it created a huge excess of mortgage debt.

Then, needless to say, the unsustainable house prices collapsed starting in 2007 and continued to fall until 2012.  How far did they fall?  Instructively, they fell right back to their trend line.  This is true with respect to both of two fundamental house price factors: inflation and rents—both tell the same story.

In the long run, there is a very close correlation between general inflation and house prices, as is shown by Graph 1 (from my own work).  The Bubble deviation from this trend is obvious, as is the fall in house prices right back to the trend line in 2012.

Graph 1 There is also a very close long-run correlation between house rents and house prices.  This is shown in Graph 2 (provided by my AEI colleague, Ed Pinto).  It displays the same pattern of bubble deviation and fall right back to the trend line in 2012.

Graph 2

With house prices having made this huge, but logical, correction, what has happened subsequently?  Well, enter the Federal Reserve and its so-called “quantitative easing”—in plain terms this means a vast manipulation of the mortgage market, by the Fed’s printing money to buy $1.5 trillion in mortgages (as well as its buying $2 trillion in long-term Treasury bonds to manipulate the government bond market).  Its goals include inducing higher asset prices, including higher house prices, to create a “wealth effect.”

Since central banks are good at producing asset price inflations, the result is no surprise: house prices have now again departed from both trend lines and are heading north once more, as shown in Graphs 3 and 4 for house prices vs. inflation and rents, respectively.

Graph 3

Graph 4

How far has the new deviation above both trend lines gone?  As far as it had in 2001-2002, when the Great Housing Bubble was already under way.  Graph 5 shows the percentage deviation of average house prices from accumulated inflation, and Graph 6 from house rents.

Graph 5

 Graph 6

So: here we go again?  Yes, if the Fed persists in promoting house price inflation.  It should stop its giant program of printing money to buy mortgages now.

Alex J. Pollock is a Resident Fellow at the American Enterprise Institute.

Also Visit
AEIdeas Blog The American Magazine
About the Author

 

Alex J.
Pollock

What's new on AEI

AEI Election Watch 2014: What will happen and why it matters
image A nation divided by marriage
image Teaching reform
image Socialist party pushing $20 minimum wage defends $13-an-hour job listing
AEI on Facebook
Events Calendar
  • 20
    MON
  • 21
    TUE
  • 22
    WED
  • 23
    THU
  • 24
    FRI
Monday, October 20, 2014 | 2:00 p.m. – 3:30 p.m.
Warfare beneath the waves: The undersea domain in Asia

We welcome you to join us for a panel discussion of the undersea military competition occurring in Asia and what it means for the United States and its allies.

Tuesday, October 21, 2014 | 8:30 a.m. – 10:00 a.m.
AEI Election Watch 2014: What will happen and why it matters

AEI’s Election Watch is back! Please join us for two sessions of the longest-running election program in Washington, DC. 

Event Registration is Closed
Wednesday, October 22, 2014 | 1:00 p.m. – 2:30 p.m.
What now for the Common Core?

We welcome you to join us at AEI for a discussion of what’s next for the Common Core.

Thursday, October 23, 2014 | 10:00 a.m. – 11:00 a.m.
Brazil’s presidential election: Real challenges, real choices

Please join AEI for a discussion examining each candidate’s platform and prospects for victory and the impact that a possible shift toward free-market policies in Brazil might have on South America as a whole.

No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.