Home Is Where the Bubble Is

Few issues have generated as much feedback as recent pieces reviewing the debates over the housing bubble and whether CPI overstates or understates inflation.

Clearly, housing and inflation are issues near and dear to most readers' hearts and minds, probably because they have a direct influence on their pocket books. A confluence of events, including today's relatively subdued trading session, has led me to revisit these issues and to attempt to see where they converge.

Last week, the government said housing starts rose 6.3% in January, the highest level since early 2000. On Monday, the National Association of Realtors reported existing home sales leapt 16.2% in January to an all-time high of 6.04 million units. Additionally, the median existing home price rose 10.2% on a year-over-year basis, the biggest jump since July 1987.

On the surface, Wednesday's report that new homes sales dropped 14.8% in January to the lowest level since June 2000 was a crack in the strong housing facade. But the drop was largely dismissed as due to "seasonal factors" and to upward revisions to sales in October, November and December. (Curiously, less attention was paid to the fact the existing home sales were also influenced by seasonal factors.)

Taking the existing home sales data on its merits, the knee-jerk reaction is that yes, housing is in a bubble and contributing to inflationary pressures. I can personally attest to this. My wife and I recently bid on a "charming" (i.e., small) duplex near Berkeley, Calif. The asking price was a big stretch for our budget, but we liked the place and have friends in the neighborhood, so decided to go for it. Our bid proved more than $140,000 short of the winning bid, which was nearly 32% above the asking price. Even in the aftermath of the bursting of the dot-com bubble, few involved in the transaction (we included) were terribly shocked by how the bidding panned out.

Clearly, the real estate market in and around San Francisco isn't representative of national trends. But I've heard similar anecdotes from readers in various parts of the country. The implication being housing today is as least as frothy as the stock market was in September 1996, when Fed Chairman Alan Greenspan agreed with then-Governor Laurence Lindsey's concerns that a burgeoning stock market bubble was "a problem we should keep an eye on," according to recently released transcripts. So the question is not whether housing is a bubble -- I think it is -- but whether it is comparable to the Nasdaq in 1996 or in 1999.

But few economists are publicly concerned about the current state of housing. Most agree with Greenspan, who during yesterday's congressional testimony essentially said that the worst thing about the housing market is that it won't provide a big boost to the recovery because housing was so strong during the downturn.

"The good news is that continuing strength in housing helped keep the 2001 recession quite mild in historical terms," Donald Straszheim, president of Straszheim Advisors, commented recently. "The bad news is that housing is unlikely to contribute in its usual cyclical way to any economic rebound in 2002 and 2003."

Lakshman Achuthan, managing director of the Economic Cycle Research Institute, expressed a similar view in an interview today: Housing "doesn't seem to be too much of a bubble," he said. "What would crush it is if [interest] rates went up. The rather high ratio of [household's] debt-to-income is palatable because rates are so low."

Noting the ECRI's future inflation gauge is near a 20-year low, "we don't see inflation, which means rates won't go up and this [housing strength] can continue," he said.

Still, housing is "unlikely to surprise to the upside" Achuthan said, agreeing that the inability of consumers to greatly increase spending is one of many "head winds" facing the economy. The ECRI continues to believe a recovery has begun, but that the rebound is likely to be subdued.

Meanwhile, John Vail, chief strategist at Fuji Futures in Chicago, recently argued that shelter costs are overstating inflation, noting the three-month rate of CPI, excluding shelter, has been negative since August. "January's CPI continues to hide much of the deflation in the current economy due to the shelter component," Vail wrote.

My initial reaction was to ask Vail if he would call my current landlord or the sellers of that duplex and explain how they're charging too much, if you strip shelter out of CPI. In fairness, Vail believes CPI understated housing costs in the late 1990s, and contributed to the excesses of that era by causing the Fed to be less vigilant about inflationary pressures than it should have been. He also agreed the proposed changed CPI amounts to a Marie Antoinette -- "let them eat cake" -- method of adjusting for prices.

But his view on shelter's current influence on CPI, and the consensus view of the housing market overall, amount to an ivory tower method of adjustment. That is, one which seems at odds with the experiences of many of us.

Enjoy the Silence

I'm taking Friday off for my birthday, which happens to coincide with the five-month anniversary of the birth of our daughter. Yes, it's been five months already. It's not as if she's asking for the keys to the car, but it is amazing how fast the time goes by, isn't it?

>To order reprints of this article, click here: Reprints