Of all the uncertainties in our halting economic recovery, the housing market may be the most confusing of all.
An open house at a home in San Francisco, where rents are relatively cheap compared with the price of buying.
McMansions may rise again, but will the collapse of the housing market change how we live?
At times, real estate seems to be in the early stages of a severe double dip. Home sales plunged in July, and some analysts are now predicting that the market will struggle for years, if not decades.
Others argue that the worst is over. As Karl Case, the eminent real estate economist (and the Case in the Case-Shiller price index), recently wrote, “Buying a house now can make a lot of sense.”
I can’t claim to clear up all the uncertainty. But I do want to suggest a framework for figuring out whether you lean bearish or less bearish: do you believe that housing is a luxury good and that societies spend more on it as they get richer? Or do you think it’s more like food, clothing and other staples that account for an ever smaller share of consumer spending over time?
If you believe housing resembles a luxury good, then you’ll end up thinking house prices will rise nearly as fast as incomes in the long run and that houses today aren’t terribly overvalued. If housing is a staple, though, prices will rise more slowly — with general inflation, as food tends to.
The difference between these two views ends up being huge, and it’s become the subject of an intriguing debate.
After digging into it, I come down closer to the luxury good side, which is to say the less bearish one. To me, housing does not rank with unemployment, the trade deficit, the budget deficit or consumer debt as one of the economy’s biggest problems. But you may disagree.
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No one doubts that prices rose roughly with incomes from 1970 to 2000. The issue is whether that period was an exception. Housing bears like Barry Ritholtz, an investment researcher and popular blogger, say it was. The government was adding new tax breaks for homeownership, and interest rates were falling. These trends won’t repeat themselves, the bears say.
As evidence, they can point to a historical data series collected by Mr. Case’s longtime collaborator, Robert Shiller. It suggests that house prices rose no faster than inflation for much of the last century.
The pattern makes some intuitive sense, too. As people become richer, they spend a shrinking share of their income on the basics. Think of it this way: someone who gets a big raise doesn’t usually spend it on groceries. You can see how shelter seems as if it might also qualify as a staple and, like food, would account for a shrinking share of consumer spending over time. In that case, house prices should rise at about the same rate as general inflation and well below incomes.
Here’s the scary thing, at least for homeowners: if this view is correct, house prices may still be overvalued by something like 30 percent. That’s roughly the gap between average household income growth and inflation over the last generation.
It’s also the overvaluation suggested by Mr. Shiller’s historical index. Today, it is around 130, which is way down from the 2006 bubble peak of 203. But it’s still far above the 1890 to 1970 average of 94.
In effect, the bears are arguing that housing was in a multidecade bubble and has now entered a multidecade slump.
The second, less bearish group of economists doesn’t buy this. This group includes Mr. Case, Mark Zandi of Moody’s Analytics and Tom Lawler, a Virginia economist who forecast the end of the housing boom before many others did. They say they believe that house prices rise nearly as fast, if not quite as fast, as incomes, and that real estate is no longer in a bubble.
This side can also make a case based on history. Mr. Case points out that all pre-1970 housing statistics are suspect. By necessity, Mr. Shiller’s oft-cited historical index is a patchwork that relies on several sources, like Labor Department surveys. These sources happen to paint a more negative picture of past house prices than some other data.
For example, the Census Bureau has been asking people since 1940 how much they think their houses are worth, as Mr. Lawler noted in one of his newsletters. The answers suggest that house values rose faster than general inflation — and about as fast as incomes — not just from 1970 to 2000, but from 1940 to 1970, as well.
Likewise, Mr. Case has dug up sales records for houses in the Boston area that were built in the late 19th century and are still around. The records show prices rising 2.5 percentage points a year faster than inflation, which is just about what income has done.
E-mail: leonhardt@nytimes.com
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