Top of the Market, Ma!
February 27, 2005
That is the sound of the real estate bubble bursting. And it's a good thing. It is obvious to me that today's real estate prices are a speculative bubble that is about to burst. Of course, this has been obvious to me for about three decades, and I've been wrong almost all of that time. Nevertheless.
One piece of evidence is the Dinner Party Index. The boom is over when more people are bored by real estate anecdotes ("My next-door neighbor got three times her asking price before she even put it on the market, from a professional mind reader who divined that she might sell … ") than have got new ones.
Another reason the value of your house is about to plunge is that the L.A. Times, the New York Times and the Washington Post all say that it isn't. A recent L.A. Times article reported that the median price of a local house had gone up only 17% in the last year. Headline: "L.A. County Home Prices Cool Slightly." Subhead: "Slowdown may not last." To describe a 17% annual increase as a "slowdown" assumes that gains of 20% or more are the norm. And the evidence for "may not last" comes from realtors whistling in the dark.
You've got a bubble when today's prices assume large future increases. If you think prices will be 20% higher in a year, you'll be willing to pay 19% more today. But if others share that assumption, today's price will already be 19% higher. Betting on future appreciation makes sense only if you are even more optimistic than other buyers. Right now, that is hard to be.
In Washington, where house prices have doubled over five years, the Post says, "Experts Predict Steady Gains in 2005, but More Moderate Than in Past Years." But whatever "experts" say, it is not the nature of price explosions to segue gracefully into more moderate growth. When today's run-ups are based on beliefs about tomorrow's run-ups, the self-feeding frenzy goes into reverse when those assumptions are dashed.
The New York Times also must be talking to experts. "In Housing Sales, Frenzy Is Giving Way to Balance," it says. And it reports from suburban Westchester County that "Housing Market Is Still Going Strong." In 2004, the median sales price rose from $564,000 to $645,000. "More and more families are seeing the residential real estate market as the best and safest place for their money," a realtor says. And the article adds chirpily, "Even the ongoing problem of a lack of houses for sale in Westchester eased somewhat last year." Like a roller coaster, a financial bubble has a moment of eerie stillness at the top. Buyers have adjusted, sellers haven't. So sales dry up. When the New York Times spins a surplus of unsold houses as a sign that "the ongoing problem of a lack of houses for sale" has been solved, it means that you had better not count on the New York Times to tell you when it's time to bail.
Let's step back a moment. All the housing in the U.S. is worth about $14 trillion. If the value of existing housing (not counting new construction) goes up 7% this year, which is the recent national average, homeowners will seem to be about $1 trillion richer. But will the nation be $1 trillion richer? No. These are the same houses, in the same place. That trillion comes partly from non-homeowners, who must pay more to buy in. And it is partly illusory. If many current homeowners tried to cash in, the drop in prices would quickly wipe out that trillion.
When the price of something goes up, two things happen: The economy starts to produce more of it, and existing units are worth more. For most of what we buy, the first effect overwhelms the second, and constrains it. An increase in the price of a can of tuna does not produce many self-satisfied anecdotes from people who have a third of their net worth locked into Chicken of the Sea. But real estate is different, mainly because it requires land. As the cliche goes, they're not making any more of it.
Perusing the real estate ads like pornography and imagining what our houses are worth is the great American pastime. But a crash, if it comes, would have some advantages. The 19th century political economist Henry George explained how rising real estate values harm the economy by operating as a tax on both labor and capital.
When the price of labor goes up, people work harder. When the price of capital goes up, people save more. Both make the country richer. But when the price of land goes up, it just makes the owner richer. There are all sorts of qualifications. But the basic point is a good one.
People do foolish things under the impression they are getting richer because their houses are worth more. They save less, they spend more. Egged on by TV commercials, they "consolidate their debts" (i.e., buy a new boat) with a second mortgage.
And who really gains from soaring house prices? First-time buyers don't. Nor does anyone who plans ever to trade up. The only beneficiaries are those who are selling their last house, after a lifetime of appreciation. The bigger the house, the bigger the windfall. This is yet another thank-you from America to the so-called Greatest Generation. I'm not sure it's necessary.
And I'm not sure it will continue. In fact, I'm pretty sure it won't. So I'm going to sell my house right now, before it's too late. Right?
Are you kidding?