A run-up in housing prices can occur due to a combination of demand, speculation, and belief that past trends in housing prices can be used to predict what will happen in the future. To test whether rises in housing prices indicate general trends of actual bubbles, some economists compare the Home Price Index with the Rent Index. When looking at this graphically, we can distinctively see the bubble that occurred in 2008.
Peter Wallison, an economist for the American Enterprise Institute, recently wrote an article in the New York Times claiming that there are many similarities between trends in housing prices today and those of the late 1990s and early 2000s. Wallison notes that from 1997-2002, housing prices grew by six percent compared to a 3.34 percent growth of rental prices. Similarly, since 2011, housing prices have grown 5.83 percent compared to an increase of only two percent in rental prices.
Among those who believe that we may be entering another bubble, opinion remains split as to its cause. Wallison blames government policies, such as low requirements on down payments, which allow individuals to buy homes too easily. He suggests that minimum down payments be raised from the current level of three to five percent to pre-1992 levels of 10 to 20 percent. Others believe that the Federal Reserve’s tax monetary policies could be fueling the rise in housing prices. Federal Reserve Governor, Jeremy Stein, stated that the Fed must be careful using expansionary tactics when risk estimates within the bond market are excessively low. Though Stein refused to voice his opinion on the Federal Reserve’s current policy, people believe that Stein would say that the Fed is being too accommodative and should take action to prevent bubbles from forming.
While some have voiced their criticism of current Fed policies, Fed Chairwoman, Janet Yellen, does not seem to be concerned about any rumors of upcoming bubbles. Her latest addresses have not even touched upon the risk that low interest rates could cause speculative run-ups in prices. In her latest address, Yellen made clear her intentions of maintaining low interest rates until the Fed deems unemployment rate is an acceptable level.
Yellen is in the unenviable position of having to decide what acceptable level of risk the Fed is willing to bring to the United States’ economy against policies that stimulate growth. Although the United States has officially been out of the recession for almost five years now, unemployment is still relatively high (6.8 percent) and the annualized rate of GDP growth in the United States in the last quarter of 2013 was an anemic 2.6 percent.
Given these facts, Yellen’s position defensible, especially when considering that no consensus has been reached on the subject of whether or not we are looking at a real bubble. According to Jed Tulko, the chief economist of the real estate company Trulia, housing prices are still undervalued by five percent. Of the 100 markets that Trulia monitors, housing prices are overvalued in only 19, compared to in 2008 when all 100 were overvalued. Tulko also notes that most of the overvalued markets are in locations that that have witnessed a significant influx of people, causing high demand and tight supply and a natural rise in home values.
For now, the best we can do is wait and see. WIth some luck, this is a temporary blip, and housing prices will soon return to a normal rate of growth. However, if this truly is a bubble, the Fed and policymakers must be especially vigilant and must make sure to clamp it down before it reaches a catastrophic size. Fresh out of the 2008 recession, many vividly remember the consequences of housing bubble’s burst and hope it does not repeat.