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Tuesday, March 18, 2008

Alex Tabarrok: Home Sweet Investment

Alex Tabarrok says things might not be so bad:

Home Sweet Investment, by Alex Tabarrok, Commentary, NY Times: Fear is ruling the financial markets. ... How low will house prices go? If prices continue to fall, mortgage defaults will move well beyond the subprime sector. Trillions of dollars in losses for investors are not impossible. But that doesn’t mean they are inevitable.

In 1997, inflation-adjusted house prices were close to their average levels over the previous half-century. Only four years later, the price of the average home nationwide exceeded anything ever seen before in the United States. Prices continued to rise for another five years, peaking in 2006 at nearly twice the average price in 1997... If house prices are heading back to the levels seen in 1997, then we are facing catastrophe.

But there are good reasons to believe that much of the increase in prices was a rational response to changes in fundamental factors like interest rates and supply. The deeper fundamentals continue to suggest strong housing prices for the future.

Sure, speculation did run rampant toward the end of the housing boom. ... Prices will fall further... So yes, we overshot the fundamentals.

Still, especially in coastal areas where zoning regulations have restricted the supply of land that developers can build on, house prices were driven up by increasing population, low interest rates and strong economic growth. ... Even in places where land seems plentiful, zoning and other land-use regulations have made it scarce. ...

Several studies estimate that the average house prices of 2004 were close to fundamental levels, so we may see prices stabilize near that level.

Granted, a catastrophe is not impossible — it did happen in Japan. ... But the ... Japanese run-up in home prices was faster and reached higher levels than the one in the United States. In addition, the Japanese population at the time wasn’t growing, and today it’s shrinking. ... As a result of these and other problems, the Japanese economy was moribund from 1992 to 2002, which kept housing prices low. ...

We have nothing to fear but fear itself, but fear itself can be pretty scary. The best way to overcome fear is to look at the long run. The typical homebuyer keeps a home for 10 years or more, so there is time for those who bought in 2005 and 2006 to weather the current decline in prices. Those who bought at the top are unlikely to see any windfalls from house appreciation, but they will not necessarily suffer from buyers’ remorse. Owning a home has its advantages: the deduction on mortgage interest is substantial and too much of a sacred cow to ever be repealed, and there is a certain security and satisfaction to owning your own home.

The collapse of housing prices certainly feels painful, and for some homeowners, it will be. But the houses are still there, as good as ever. Most of the gains going up were paper gains, and most of the losses going down are paper losses.

The strength of an economy comes, fundamentally, from what it can produce. Can America still produce homes? Yes. Can America still produce desirable urban and suburban areas that people are willing to pay a fortune to live in? Yes.

That’s the real bottom line. The United States has some of the most valuable real estate in the world. Markets should not forget that.

That we might come out of this relatively unscathed provides hope, but "a catastrophe is not impossible," and risk management dictates that we take action to try to prevent a catastrophe from happening rather than relying upon hope to save us. The other thing is that, with home ownership so desirable and beneficial, I'd think we'd want to make sure that home ownership is possible across wide swaths of the population, and that means turning our attention to the struggles of workers who have seen very little in the way of real wage gains even in the best of times.

    Posted by on Tuesday, March 18, 2008 at 12:30 AM in Economics, Housing | Permalink  TrackBack (0)  Comments (75)

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