Abstract
This research was motivated by the excesses of public policy since 2008 in an attempt to re-inflate the housing markets. Is it even possible or desirable to utilize such a vast amount of public resources to inflate a single sector such as housing that suffered from such a spectacular bubble and collapse? The consequences suggest that, as a way to bolster real household incomes and aggregate output, these policies have disappointed. In contrast, there is a fear that the monetary stimuli will lead to unsustainable housing price inflation, if not a bubble. I address these questions in the analysis from the standpoint of determining the stable equilibrium and sustainable house price appreciation rates consistent with the growth of median household income. The problem of identifying stable house price appreciation is to first identify the major proximate determinants of household demand for housing. A second is to show empirically the movement, deviation, and variation of these factors over time compared to housing prices. I use median household income as the major demand factor for houses and median single family house prices as an indicator of the price. A third is determining the stable equilibrium of the growth of these factors and the appreciation of housing prices consistent with them. And a fourth is the adjustment process when there are small deviations from steady-state equilibrium compared to when deviations are large. It is this last distinction where the chaos theory of self-organizing systems and irreversibility of the housing market system enters to explain how the adjustment process is chaotic in this case. I conclude that, as of the beginning of June 2016, the evidence is overwhelming that housing price appreciation is in a bubble that will likely lead to significant declines in house price appreciation if not in house prices. An important policy recommendation to mitigate these declines and hasten a house price recovery follows. The continuation of expansionary monetary policies will only delay house price adjustments and lead to more severe price declines.
Highlights
This research was motivated by the excesses of public policy attempting to re-inflate the housing market after the disastrous collapse of house prices from mid-2006 to the approximate beginning of a turnaround in March 2012 (Figure 1)
Approaches to assessing house price stability, or better yet, instability of house price fluctuations and booms and busts, have concentrated on analyzing variations in median house prices and house price indices such as S&P-Case-Shiller or CoreLogic time series. This approach has not yielded much in the way of analytical results or in identifying equilibrium house price changes. It has been thought during the house price boom of 2003-2006 that 10 percent or greater annual increases in median house prices was to be expected indefinitely and that these represented sustainable equilibrium house price appreciation
The approach taken in this study is to recognize that households choose housing based on a number of factors, but like other durable consumer goods, household income, expected long run household income, mortgage rates and life-cycle stage, are the primary determinants of the choice of how much households are willing to spend on housing. The conclusions of this approach are: 1) in equilibrium median house prices should appreciate at approximately the same rated as median household median incomes; 2) movements far away from the equilibrium value of median house price-median income ratio are not sustainable and are unstable
Summary
This research was motivated by the excesses of public policy attempting to re-inflate the housing market after the disastrous collapse of house prices from mid-2006 to the approximate beginning of a turnaround in March 2012 (Figure 1). House prices have been increasing since 2012, as of February 2016 they remained below the peaks that were set in mid-2006 and only regained these highs in November 2016, over 10 years in the making (Figure 1) Why have these unprecedented policies been so ineffective in inflating house prices until 2012 and will they end in an unsustainable housing price boom if they persist for much longer? According to the Flow of Funds accounts, the total rise in residential property values from the low point in 2011 Q2 of $16.2 trillion to 2016 Q4 was $6.9 trillion and was only $1.6 trillion or 2.7 percent above the peak value set in 2006 Q4 of $22.5 trillion.1 [1] These lackluster results are confirmed by other data such as median existing house prices that peaked to over $245,400 in 2006 and recovered to that level in 2012, 6 years into recovery (Figure 2).2 [2] by 2016 median house prices had risen by 27 percent to $318,600.
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