Here we go again?

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Article Highlights

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

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

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

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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.

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About the Author

 

Alex J.
Pollock
  • Alex J. Pollock is a resident fellow at the American Enterprise Institute (AEI), where he studies and writes about housing finance; government-sponsored enterprises, including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks; retirement finance; and banking and central banks. He also works on corporate governance and accounting standards issues.


    Pollock has had a 35-year career in banking and was president and CEO of the Federal Home Loan Bank of Chicago for more than 12 years immediately before joining AEI. A prolific writer, he has written numerous articles on financial systems and is the author of the book “Boom and Bust: Financial Cycles and Human Prosperity” (AEI Press, 2011). He has also created a one-page mortgage form to help borrowers understand their mortgage obligations.


    The lead director of CME Group, Pollock is also a director of the Great Lakes Higher Education Corporation and the chairman of the board of the Great Books Foundation. He is a past president of the International Union for Housing Finance.


    He has an M.P.A. in international relations from Princeton University, an M.A. in philosophy from the University of Chicago, and a B.A. from Williams College.


  • Phone: 202.862.7190
    Email: apollock@aei.org
  • Assistant Info

    Name: Emily Rapp
    Phone: (202) 419-5212
    Email: emily.rapp@aei.org

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