Are Bubble Prices Gone Forever?

John Carney suggests that the housing values enjoyed during the recent bubble may never come back, and he links to a Charles Hugh Smith essay for support. His points are summarized thusly:

1. Once the bubble in an asset class pops, it never reflates. "It is simply a truism that bubbles never reflate, ever. Tulip bulb valuations did not rise to stratospheric heights after the Tulip Craze popped, and the Nasdaq dot-com bubble did not reinflate, either, for the very good reason that bubbles are never based on rational valuations--they are based on the psychological state of mania which cannot be reinstated once lost," Smith writes.

2. Inflation destroys the gains anyway. Even if prices start to climb, they'll be battling against inflation. With all the new government debt being issued, we're likely to face a big jump in inflation. This will means that even if your house is worth as much as it was in 2006 four years from now, in real terms it will have lost value.

3. If we somehow avoid inflation, deflation will mean house prices keep sinking. "In deflation, debt grows ever more burdensome as money becomes more valuable and wages and income drop. As a result, assets dependent on debt ( that is, real estate) drop in value. In deflation, real estate become a "capital trap" which loses value as cash gains in value. As incomes plummet, so do rents, i.e. the income stream which real estate earns, further impairing its value," he explains.

4. The combination of low interests rates and loose lending that fueled the boom is dead. The government is pushing down interest rates, cramming down mortgages and halting foreclosures in hopes of re-inflating the housing bubble but it won't work. It took loose and even fraudulent lending to push prices as high as they went, and those practices are dead thanks to closer supervision and the financial collapse. What's more, interest rates are sure to climb higher again "once the rest of the world either runs out of cash or the desire to give us all their surplus capital."

5. Demographics. All probable future population growth can be easily accomodated with the existing housing stock, which means that there won't be some population growth led surge in prices.

Carney hedges, saying that, "In some areas, prices might climb that high again," but not in most markets. There are a couple of problems with these arguments. First, I don't think most people realize how localized the really bubbly bubble was. How many of the twenty Case-Shiller markets do you suppose saw their prices increase by 100% or more from 2000 to the peak of the bubble? Just nine. Five in the greater California market, two in Florida, New York, and Washington. There are indications that the worst of the fallout is largely contained to those areas (and primarily to the California and Florida markets). William Lucy and graduate student Jeff Herlitz at the University Virginia found that:

[M]ost foreclosures have been concentrated in California, Florida, Nevada, Arizona and a modest number of metropolitan counties in other states. In fact, they claim that "66 percent of potential housing value losses in 2008 and subsequent years may be in California, with another 21 percent in Florida, Nevada and Arizona, for a total of 87 percent of national declines."

"California had only 10 percent of the nation's housing units, but it had 34 percent of foreclosures in 2008," Lucy and Herlitz reported.

Within markets there is also variation:

Although there are pockets of substantial declines, claims that overall housing values have tanked nationwide are exaggerated, they said. "In the Washington, D.C. metropolitan area, for example, prices have barely changed in the District of Columbia, Alexandria and Arlington County, and parts of Fairfax County in Virginia. The largest price declines (more than 30 percent in 2008) have been in Prince William County, Va., but even there, the range of price declines in its six zip codes ranged from 49 percent to only 6 percent."

So while basically every part of the country has suffered some decline in prices in the crash, many metropolitan areas never saw prices get that out of line, and haven't seen prices fall that far from peaks.

Just based on that alone, I'd say that bubble valuations in a lot of markets will be reached, some perhaps in the not too distant future. Once the odd demographic argument is set aside, a return to bubble values in many (though not all, by any stretch) is all but certain. I have a very difficult time understanding the point that the current housing stock will be sufficient for future populations. Census projects that the American population will grow by some 130 million people, or nearly 50%, by 2050. That's a lot of new households! To fit within the current housing stock, average household size would have to grow considerably between now and then. To explain how this would happen Smith writes:

As noted here many times, housing density (number of people per structure) has been falling for decades. As density rises, all future population growth can be easily accomodated with the existing housing stock.

Which is confusing, to say the least. I don't think prices in the Inland Empire or exurban Phoenix will recover to bubble levels anytime soon, if ever. Most of the country isn't facing so dire a situation.

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