Real-Estate Bubble

August 29, 2006

This graph by noted pessimist Yale economist Robert Shiller shows that housing prices soared beyond reason these past few years. While I agree with Shiller that housing prices are insane, I don’t think it is as wildly insane as his graph depicts. Housing prices are largely determined by how much your customers can afford, which is determined by their average salary and current interest rates. Since incomes for upper middle class professionals have gone up and interest rates were extremely low, housing prices should have gone up. Another factor is that popular cities (e.g., New York, San Francisco) saw a huge reduction in crime, finally opening the area to gentrification by dual-income yuppies, which put more upward pressure on prices. Finally, improvements in the debt markets allowed banks to sell riskier loans but spread the risk to other investors, giving us 0% down loans and other innovations. This becomes more obvious in light of the fact that prices did not rise too fast in the vast boring stretches of America. Also consider that prices climbed higher in London and Sydney than in New York, so this isn’t strictly an American phenomenon. The result is that prices will come down hard in the short-term as speculators exit the market, but they will stabilize in a year and rise slowly after that until incomes & interest rates match home prices. Of course, if you take financial advice from an anonymous blog then you should send me money for my get-rich quick seminars. Leave your credit card number in the comments. 😉


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