Bubble trouble?

The biggest problem with asset bubbles may not be deciding what to do about them - but knowing if you're in one. Take the US housing market. Calculated Risk, via Angry Bear, say's we're in a bubble:

Nearly everyone now knows there is a housing bubble, but apparently the allure is still too great for some.

William Polley is not so sure, but plenty of other's agree, from the American Enterprise Institute to Merrill Lynch (hat tips: Calculated Risk, again). Inevitably, we are now seeing housing bubble blogs pop up too.

A 25 March New York Times story (registration required) by Motoko Rich and David Leonhardt has added fuel to the debate, warning that:

Real estate-crazed Americans have started behaving in ways that eerily recall the stock market obsession of the late 1990's.

and providing the usual idiotic remark one gets at the peak of any asset boom, from Ron Shuffield, president of Esslinger-Wooten-Maxwell Realtors:

"South Florida," he said, "is working off of a totally new economic model than any of us have ever experienced in the past."

Of course, worrying as such signs undoubtedly are, the looming housing bubble is an old meme. In some other OECD economies - Australia and the UK, to name two - similar dire predictions have so far come to nought. Both markets have seen the rapid pace of house price increases slow, and in Australia's case decline. But the sky has not fallen in.

Meanwhile, New York Fed economists Jonathan McCarthy and Richard W. Peach recent paper arguing that the US is probably not in a housing bubble is well worth a look (hat tip: Newmark's door).

But is it really so easy to identify an asset bubble that is set to burst? As distinct, that is, from a sustained market rally or asset boom that has overextended itself and will in time deflate? Recent Federal Reserve research says it isn't. Econometric Tests of Asset Price Bubbles: Taking Stock by Refet S. Gurkaynak, published by the Fed in January, surveys econometric tests of asset price bubbles to show that:

....despite recent advances, econometric detection of asset price bubbles cannot be achieved with a satisfactory degree of certainty. For each paper that finds evidence of bubbles, there is another one that fits the data equally well without allowing for a bubble. We are still unable to distinguish bubbles from time-varying or regime-switching fundamentals, while many small sample econometrics problems of bubble tests remain unresolved.

Amidst all the hype, it's well worth a read. Dare I suggest that Stephen Kirchner at Institutional Economics was probably right when he commented last month:

When confronted with asset price inflation, many economists are all too ready to declare a ‘bubble,’ which saves them the bother of actually having to think seriously about the economics underlying asset prices.

Comments

[CalculatedRisk]

Thanks for the mention. I don't call it a bubble lightly - it takes both overvaluation based on fundamentals and speculation. A couple of years ago I started thinking housing was overvalued, but not enough to worry about. Now I'm concerned.

I think it is important to note that housing "bubbles" typically do not "pop", rather prices deflate slowly in real terms, over several years. House prices display strong persistence and are sticky downward. Since real estate markets do not clear immediately, what we usually observe is a drop in volumes.

Best Regards!

[William Polley]

Like Calculated Risk, I will begin by thanking your for mentioning my blog.

What I'm "not so sure" of is whether this is a widesrpread problem. In many areas in the midwest, for example, it might look like values are going up very rapidly because the building is taking place in wealthy suburbs. I don't see much speculation around here, but there are $300,000 houses going up like gangbusters with people living in them, not speculating on them. That's less of a problem. Of course, I'm not a broker or an appraiser or anything like that, but in my area the fundamentals don't seem too far out of line.

Quotes like the one about south Florida in the Times article that I posted, on the other hand, make me really nervous. Sounds like the 1920s.

In short, I think the real bubble is limited to certain types of properties in certain regions and is likely to stay that way until the air starts leaking out of the bubble. Calculated Risk's comment above seems on the mark.