Housing: Part 277 - Was there an internet bubble?

While I generally find the notion of "bubbles" to be overstated, there are a couple of markets that seem reasonably to fit that description.  (1) The Contagion cities in 2004 and 2005, when mass migration from the Closed Access cities contributed to valuations that were unlikely to be sustainable, and (2) the internet stock bubble.

On number (2), I think there is a credible explanation that somewhat salvages an efficient markets perspective: We invented the internet.  There has been a undeniable technological revolution such that even residents of the developing world now frequently have smart phones.  If there was a miscalculation, it was that firms couldn't figure out how to monetize it, and most of the value accrued to consumer surplus instead of to producer surplus.  The value of the products and services the firms were producing in 2000 was worth as much as the stock market estimated that it was.  It's just that the value was captured by consumers through real (if sometimes unmeasured) growth instead of by firms through profits.

This is an optimistic story, and I think there is something to it.  But, it is at best a partial story.  Any story will be a partial story.  I was poking around the stock market back then, and there were hardware firms - basically electronics manufacturing firms that had revenues from infrastructure buildup - that had traded at multiples that were far above levels that I could imagine ever being justified by any realistic level of production.  I hate to call something a bubble because of conclusions from my own imagination because most of the time I see things being called bubbles, it looks to me like it is the observer's imagination that is off, not the valuation they are second-guessing.  But, it does seem like there was froth.

But, I have another story, which may also provide a partial answer.  This is not an optimistic story.  And, this story is much more easily verified and quantified.  Frankly, I can't believe it hadn't fully occurred to me until now.  The reason the internet bubble popped wasn't because the added value went to consumers.  The reason it popped was because the added value went to real estate owners.  Those technology valuations in the late nineties, at some point, had to be justified by profits, and those profits didn't fully materialize.  Where did they go?  They went to bloated wages, because in the cities where almost all of those firms are located, they must pay their workers a 50% wage premium, and that wage premium flows on to the owners of real estate.

Of course, the common parlance is to blame this all on money, on the Fed, on unsustainable borrowing, and to just conclude that there was an unsustainable tech bubble which we tried to replace with an unsustainable housing bubble.  Readers know that there are many problems with that story.  First and foremost, a problem with that story is that the most expensive homes have high prices that are fully justified by high and rising rents.  It was incorrect to conceive of those rising property values as sources of home equity borrowing for consumption we couldn't afford.  It is at least as accurate to conceive of those rising property values as sources of collected economic rents for owning property that has been politically protected from competition, so that it earns monopoly rents.

Those Closed Access real estate owners got their spoils the old fashioned way, not from hapless lenders, but from limited access political orders - local planning commissions that weren't sure the new condo building next to the train station was really necessary.

This is admittedly slapdash.  But, here is a graph that compares the real value of US nonfinancial equities to the value of the sum of equities and real estate.  If we just look at equities, the value peaks in 2000, and never comes close to reaching the same relative level above trend.  If we look at both, the value of residential real estate owned by households plus the value of equities hits the trendline in 2000, then hits it again in 2005.

Then, we took a sledgehammer to credit markets and the economy to make sure that wouldn't happen again.  Keep in mind, because of capital repression in mortgage markets, real estate is probably collectively undervalued by more than $5 trillion.  (In other words, if households who could afford homes were able to get mortgages to buy them, they would likely be able to bid home values up from the current cumulative value of about $27 trillion.)  In addition, we have underinvested in new housing stock over the last 10 years by at least another $5 trillion.  In this way, we have brought this total value down from the trend.  Surely, some significant amount of innovation and production has also been lost due to the geographic obstacles we have in place that prevent workers from moving to prime locations.

We didn't replace an internet bubble with a housing bubble.  Housing owners just claimed their fat portion of the gains in production.

Currently, households own about $27 trillion of residential real estate, and nonfinancial equities are worth about $25 trillion.  If we had started building hundreds of thousands of homes around New York, Boston, LA, and San Francisco in the late 1990s, would we currently have equities worth something like $40 or $50 trillion, instead?  In that case, even though we would have spent trillions on residential investment, the value of real estate would still probably have been about $30 trillion, because the value would have been based on the value of shelter, not the value of political exclusion.