Home Price Bubble?

In a speech delivered in early March of this year, Federal Reserve Board Chairman Alan Greenspan discounted the macroeconomic risk of a housing price bubble. Existing home prices rose by 7% during 2002 and by nearly 33% over the past four years. Some analysts have been expressing concern that the housing market may be exhibiting the same unsustainable growth that the stock market exhibited in 1999-2000. Greenspan noted that while it was highly unlikely that home prices would continue to appreciation at recent rates, the similarities with the stock market end there. So does the risk of a national economic hangover from the bursting of a housing price bubble.

Greenspan acknowledges that while average housing prices could fall for a quarter or two (as was the case in 1990) the speculative bubble component of the housing market is surely far smaller than was the case for the stock market. He cites three reasons.

First, selling a home is a far more expensive proposition than selling a stock, entailing physical moving costs in addition to transaction costs in the form of commission, fees and taxes. Consequently, the buying and selling frenzies that build up (and subsequently deflate) stock price bubbles are far less likely to occur in housing markets.

Second, although mortgage interest rates may be similar throughout the country, housing markets are not national in the United States. Housing prices are driven by local conditions, making simultaneous bubble conditions in multiple cities unlikely. Furthermore, a deflation in one metropolitan area is unlikely to trigger similar sell-offs in others, since there is no arbitrage of one housing asset in one city for a similar asset in another city.

Lastly, housing demand remains healthy and there are no signs of overbuilding. Greenspan cited Census Bureau data that indicate that one-third to one-half of new household formations in recent years resulted directly from immigration.