Housing Bubble: Myth or Reality?

verfasst von - ELLI -, 05.03.2003, 15:28

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<font color="#002864" size="1" face="Verdana">http://www.mises.org/fullstory.asp?control=1177</font>
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<font face="Verdana" size="2"><font color="#002864" size="5"><strong>Housing Bubble: Myth or Reality?</strong></font>
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<font size="4">by Frank Shostak</font>




<font size="2">[Posted March 5, 2003]</font>




<font size="2">said
on Thursday, during questioning by the Senate's special committee on aging,
that he does no believe that a housing price bubble exists on a national
level in the United States. </font>




<font size="2">"The notion of a bubble bursting and the whole price
level coming down seems to me as far as a national nationwide phenomenon, is
really quite unlikely," Greenspan said. He does say that it
is unrealistic to believe that housing prices will increase at the current
rate, but as for a bubble, he says no way.</font>




<font size="2">Is he right? To provide an answer to this one needs to
establish, or define, exactly what a bubble is.</font>




<font size="2">We can define a bubble as activities that spring up on the
back of loose monetary policy of the central bank. In other words, in the
absence of monetary pumping these activities would not emerge. Since bubble
activities are not self-funded, their emergence must come at the expense of
various self-funded or productive activities. This means that less real
funding is left for productive activities, which in turn undermines those
activities. In short, monetary pumping gives rise to the misallocation of
resources, which as a rule manifests itself through a relative increase in
non-productive activities against productive activities.</font>




<font size="2">When new money is created, its effect is not felt
instantaneously across all market sectors. The effect moves from one
individual to another individual and thus from one market to another market.
Monetary pumping generates bubble activities across all markets as time goes
by. Once, however, the central bank tightens its monetary stance, i.e. reduces
monetary pumping, this undermines various bubble activities. The bubble bursts.
Since monetary pumping generates bubble activities across all markets,
obviously the eventual bursting of the bubbles will permeate all markets—including
the housing market.</font>




<font size="2">As a rule the act of bursting bubbles, or the liquidation of
nonproductive activities, is set in motion by a tighter monetary stance of the
central bank. A tighter stance purges various nonproductive activities thereby
eliminating past excesses, which in turn lowers the ratio of
nonproductive-to-productive activities, so to speak. In short, a tighter
stance brings harmony to the structure of production and sets the foundation
for a sustainable economic revival. A situation however, can occur where the
bursting of bubbles takes place despite an easy stance by the central bank.
This can emerge when the pool of real funding begins to shrink.</font>




<font size="2">Historically, between 1970 to 1994 there was a 12-month lag
between changes in the federal funds rate and its effect on industrial
production (see chart). Since 1995 onward, the inverse correlation between the
lagged fed funds rate and industrial activity ceased to exist. We suggest that
this has something to do with the possibility that the pool of real funding is
in trouble. In other words, as long as the pool of real funding is growing the
loose monetary policies of the central bank appear to"work". This
is because the nonproductive activities supported by loose monetary policies
masquerade as wealth generating activities.</font>




<font size="2">However, this illusion is shattered once the pool of real
funding stops growing. There is the possibility that this is what may be
taking place at present. Despite the aggressive lowering of the fed funds rate
since the end of 2000, industrial activity in relation to its long term
trend has remained depressed (see chart).</font>




 
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<td><font size="2"><strong>AMS
</strong></font><font size="2">in relation to the trend between
1959-1979; i.e., the trend prior to financial deregulation, can assist in
assessing the magnitude of monetary pumping since 1980 onwards.</font>




<font size="2">[img]" alt="[image]" style="margin: 5px 0px 5px 0px" /> Thus
in December 2002, money AMS stood at 181% above the trend (see chart).
This massive monetary expansion has been accompanied by a steep downtrend in
the federal funds rate. From 17.61% reached in April 1980, the federal
funds rate had collapsed to 1.25% as of February this year (see chart).</font>




<font size="2">If the pool of real funding is in trouble at present then
this is likely to undermine various markets including the housing market.
Moreover, the more aggressive the Fed's loose stance is, the worse it is for
the productive capacity of the economy. This in turn raises the likelihood
that the liquidation of past excesses is likely to be imposed in earnest this
time around.</font>




<font size="2">Observe that the likely burst of the housing market bubble
is on account of the decline in the pool of real funding and not a tighter
stance on the part of the Fed. This contradicts the popular view, which holds
that as long as the Fed keeps interest rates at low levels the housing market
will remain strong.</font>




<font size="2">The magnitude of the housing price bubble is depicted in the
following chart in terms of the median price of new houses in relation to the
historical trend between 1963-1979. In this regard the median price stood at
73% above the trend in December 2002 (see chart).</font>




 
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<font size="2">There are already signs that the housing market may not be
far from its peak. Purchases of new homes dipped to their lowest level in a
year in January. The Commerce Department said new home sales fell to a
seasonally adjusted annual rate of 914,000 units in January, the
slowest pace since January 2002. The percentage drop, at 15.1 percent,
was the biggest one-month decline in nine years.</font>




<font size="2">Our monetary analysis raises the likelihood that the
cyclical component of home sales is likely to remain under pressure (see chart).
Furthermore, year-on-year, the median price of new houses fell by 2.6%
in January after rising by 6.7% in the previous month (see chart).</font>




 
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<font size="2">Although commercial bank real estate loans remain buoyant,
the likely weakening of the housing market will put a brake on the growth
momentum of these loans (see chart). This in turn is likely to weaken the
growth momentum of money AMS and further undermine various nonproductive
activities. There are some indications that demand for mortgages may be
weakening. The MBA mortgage applications index fell by 7.5% in the week
ending February 21 from the previous week (see chart). Moreover in the week
ending February 19 commercial bank real estate loans fell by almost $10 billion
from the previous week.</font>




 
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<font size="2">Frank Shostak is an adjunct scholar of the Mises Institute
and a frequent contributor to Mises.org.  Send him </font><font color="#000080" size="2">MAIL</font><font size="2"> and
see his outstanding Mises.org </font><font color="#3571ca" size="2">Daily
Articles Archive</font><font size="2">.


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• Housing Bubble: Myth or Reality? - - ELLI -, 05.03.2003, 15:28