Editor's note: In the July issue of Townhall Magazine, where this column originally appeared, AEI's Alex J. Pollock explains why now is definitely not the time for the Fed or politicians to promote further rapid house price inflation.
Would it be possible to have a new housing bubble? Yes, of course. How long does it take to forget the lessons of the last crisis? By the historical record, about 10 years, and it is already eight years since the peak of the great U.S. housing bubble of 1999-2006, and five years since the end of the financial crisis of 2007-2009. As former-Federal Reserve Chairman Paul Volcker wittily observed, “About every 10 years, we have the biggest crisis in 50 years.”
Real estate is often at the center of financial crises, both here and in other countries, because it has the most leverage, that is, the most debt relative to value, of any economic sector. This makes it vulnerable to cyclical downturns in which prices go down when people thought they would go up. The U.S. had big real estate busts in the 1970s, 1980s, 1990s, and of course, the 2000s. Next?
Real estate is also a huge sector, so its troubles have big financial consequences. Housing in particular is politically potent and attracts government efforts to subsidize and expand debt. Of the $9 trillion in mortgage loans in this country, the 79.9 percent government-owned and heavily subsidized Fannie Mae and Freddie Mac represent $5 trillion.
When the government pushes credit at housing, it makes house prices go up. This leads to a push for yet more credit. Washington discussions are now turning to lowering mortgage loan standards to encourage more loans, especially to riskier borrowers. The Senate Banking Committee has approved a bill to have the government explicitly guarantee mortgages. The new head of the regulatory agency for Fannie and Freddie appears to be more interested in being a promoter of housing debt than a guardian of financial soundness.
All the principal central banks of the world, including the Federal Reserve, have committed themselves to perpetual inflation. They have also manipulated interest rates to extremely low levels. Central banks now routinely make what would historically have been shocking statements that inflation is too low. But they have succeeded in generating a lot of one kind of inflation: asset price inflation. This is certainly true in bonds, in stocks, in collectibles, and in houses.
Looking around the world a bit, we find this: “The biggest domestic risk is the nation’s housing market, where prices are rising fast and buyers are taking on more debt.” That was the view recently expressed by the governor of the Bank of England in discussing what one astute financial commentator called “the runaway U.K. housing market.” This is after England had a housing bubble and bust in the last decade, just like we did. The Bundesbank is worried about inflated house prices in Germany. Brazil is said to have a housing bubble. And China is already experiencing the opening stages of the painful deflation of its housing bubble. When central banks create a lot of money, it goes somewhere—often enough to house prices.
What about the U.S.? House prices on average have been rising rapidly since the 2012 bottom. The fourth quarter 2013 Case-Shiller 20-major city house price index was up 13 percent for the year. The broader 380-market CoreLogic-Case-Shiller Index was up 11 percent for the same period. From their trough, national average house prices are up about 20 percent. On the other hand, they are still 21 percent below their 2006 peak—not that we want to get back there anytime soon! Overall, does the current level look too high or too low? We need some historical perspective.
Graph 1 is the Case-Shiller National Home Price Index from its beginning in 1987. The bubble, the ensuing shrivel, and the recovery are readily apparent. The trend line is based on the period 1987-1999—the trend is about 3 percent annual price increases. The recent price increases have brought us just about back to the trend line.
Graph 2 gives us a lot more history—60 years, back to 1953. It compares the growth in the consumer price index to estimated national average house prices, with the egregious bubble obvious. The strong correlation of house prices to inflation is also obvious. On this longer look, house prices got down just to their trend, and have now pushed back somewhat above it.
I think we can conclude that we are not at this point in a housing bubble again, but now is definitely not the time for the Fed or politicians to promote further rapid house price inflation. A new housing bubble in the future is certainly possible, but the every-10-years crisis may arise from something entirely different—something now unthought of. •
Alex J. Pollock is a resident fellow at the American Enterprise Institute in Washington, D.C. He was president and CEO of the Federal Home Loan Bank of Chicago 1991-2004.