Tuesday, July 30, 2013

There was no housing bubble


I think most of the real estate inflation of the aughts was a product of demographics - baby boomers were bidding up the price of low-risk stores of value.  Houses were seen as an especially useful means for this.  Of course, Fannie, Freddie, subprime, securitizations, Basel II, CRA, etc. etc., fed the price increase.  But, we are seeing some decent housing inflation now, again, without many of those factors.  It seems reasonable to me that baby boomers would be willing to bid the housing stock up above what you might normally expect, given rent/own ratios, etc.  It's related to the low real interest rates we are seeing.  The demographic pressures are strong enough to push the marginal investor to a new price level.  We should expect this to be at least as strong in housing as in bonds.

It's probably a factor in gold, too.  Gold is normally seen as an inflation hedge, but I think it correlates more strongly to real interest rates, and the increases in gold prices over the last decade are a reaction to low real interest rates, not inflation.

For several more years, we should expect gold, bonds, and housing to return negative real returns in a low inflation environment.  When baby boomers have fully entered retirement, so that they are, on net, dissaving, we will see those trends reverse so that asset prices will decline (returns will increase), and inflation pressures will increase.  Normally, I would expect these pressures to be absorbed by market arbitrage, but I think the demographics are too strong, and the time frames too long, for that to happen completely, so that we will continue to see long term predictable trends in these prices.

One cognitive habit that hurts us here is the tendency to think of price changes in terms of changes in the number of buyers and sellers, but of course, every transaction has both a buyer and a seller.  I think it is usually more helpful to think of price changes in terms of changes in the expected value of assets.  Especially savings, whose value is composed of unknown future cash flows, the value of the savings vehicle can change based on a change in expectations as well as a change in discount rates applied to those expectations.  Prices can change without a single trade.


  1. I made a somewhat similar point a few years ago.

    I didn't deal specifically with the reasons for the high demand to save. I'm not convinced it was all about demographics. Another factor (which is apparently no longer present) was the savings glut coming out of East Asia, partly as a result of Chinese government policies.

    1. Thanks for the link, Andy. That was an interesting post with some great comments.

      There are enough interesting questions here to keep someone busy for a lifetime. It's unfortunate that public discourse about finance so frequently stops at the easy stories of ignorant greed and fear and of cons and marks.

      Your point about international savings glut is a good one too. I did a recent post relating to that:

      There is an interesting story here about comparative advantage, not just in production, but in risk. It seems like the US has developed a standing as the superior producer of low risk or risk free securities. It turned out that some of those securities had more risk than the investors had bargained for.

      Foreign investors could get easy exposure to Treasuries and housing securities, pushing Americans into the real estate itself, in pursuit of a savings vehicle.

      It seems like American corporations are serving as a sort of financial intermediary, collecting savings in the low risk US context and investing it in high risk emerging markets.