November 13, 2017

The Big, Bad "B" Word

The scars are still fresh from the collapse of last decade's house price bubble. Even as the housing industry continues to recover, many are keeping an eye out for the next bubble. In this month's Insight, we investigate the possibility that we're currently in a house price bubble and discuss the likelihood of being able to spot the next one.

The answer to the first part is relatively easy: Despite the substantial house price increases in recent years, and the evidence that house prices are unusually high in a growing number of metro areas, we are not yet in a housing bubble.

The second part is a little harder.

First, we need to define a house price bubble. In the words of noted economist Robert Shiller:

A bubble is a kind of social epidemic—a period of feedback, where price increases generate enthusiasm among investors, who then bid up prices more, and then it feeds back again and again until prices get too high. During that period, people are motivated by envy of others who made money doing it, regret in not having participated and the gambler's excitement. Stories develop that justify the bubble, they become current and then people think they're right because everyone's confirming the stories. So, that happens. Eventually prices get too high and the bubble bursts.

The problem is that bubbles are extremely difficult to identify as they are forming. There is always the possibility prices will adjust gradually to economic fundamentals rather than collapse suddenly. Moreover, it's possible that claiming to identify a bubble will, by itself, spook lenders and investors and trigger a crash that didn't need to happen. It's always tempting to monitor conditions a little bit longer rather than take action, especially since it may be difficult to know what sort of action might prevent the bubble from bursting.

In our insight, we describe our approach to monitoring house price risk, both nationally and regionally. We also compare house price metrics today to the experience of last decade to see if any of the last bubble's symptoms are recurring. Finally, we speculate about how today's house prices might return to normal. Will we have a soft landing, or will we suffer through another house price collapse? Or is there a third possibility?

Read our November 2017 Insight to find out.