Building on the Bubble
Houston Chronicle, May 17, 2004
Press Enterprise (Riverside, CA), May 14, 2004
Duluth News-Tribune, May 17, 2004
Miami Herald, May 22, 2004
Milwaukee Journal Sentinel, May 23, 2004
The Pantagraph (IL), June 20, 2004
Survivors of the recent stock market crash should rightly be worried that a sharp drop in housing prices could deliver a second major blow to their retirement dreams.
The fact that there has been an unprecedented run-up in home prices over the past eight years creates the possibility for an unprecedented decline in the years ahead -- just as the spurt in the NASDAQ at the end of the '90s created the basis for its plunge after March 2000.
The basic facts are striking. According to the government's House Price Index (HPI), the increase in the sale price of an average house has exceeded the overall rate of inflation by more than 40 percentage points over the past eight years. In the past, house prices had largely kept pace with the overall rate of inflation.
It is important to recognize what this index shows -- the HPI tracks the change in price for the same home. This means that the rise in this index is not being driven by better quality homes, it is being driven by homes of the same quality costing more.
At the moment, this has mostly affected the rental market, leading to record vacancy rates and falling rental prices. However, as home prices continue to rise, many potential homebuyers will opt to rent, especially when interest rates rise.
And vacant rental units can be put up for sale. The end result will be a loss of $2 trillion to $3 trillion in housing wealth, and a downturn that is even worse than the fallout from the stock market crash.
Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.