Wednesday, September 4, 2019

An Expectation View Of The 2008 Housing Crisis

Back in October 2008, I published a list on this blog [below] of some possible future sociological and economic scenarios that would affect the then current prices of homes through a change in expectation. In looking at that list today, it surprises me that so many occurred.
Tuesday, October 21, 2008, "Home Values Were Not In A Bubble" Posted By Milton Recht:
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In a rational expectations, efficient market world which is the world economic research finds we live in, house price changes are due to changes in the expectations of the economic fundamentals related to the need, demand and value of houses. Thus, current house prices reflect their true economic value and homes are not undervalued whether due to the unavailability of credit or for other reasons. Arms-length housing market transactions, of which there are still many, occur at the true current price of housing.
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Some of the possible future scenarios which would decrease the current value of a home are:
  1. a significant and long-term decline in household formation.
  2. a significant and long-term decline in population growth in the US due to changes in birthrate or immigration policies.
  3. an increase in adult children living in their parents home (including after marriage or cohabitation).
  4. an expectation of an increase in mortality or a shortening of life expectancy due to war, disease or natural or man made disasters. [Add opioids and suicide.]
  5. a change in our preferences so as to prefer multi-family or apartment type dwellings as opposed to single family homes decreasing the need for single family homes.
  6. a significant increase in the costs of owning and maintaining a home which lowers its economic value to a purchaser because of the expected increase cash outflow during ownership.
  7. a decline in both household income or the expected growth rate of household income.
  8. an alternative technology for building homes which will dramatically reduce the costs of building new houses.
  9. a change in home related taxation such as a denial of mortgage interest or real estate taxes deductions.
  10. a substantial expected increase in real estate taxes.
  11. other possibilities that affect the economic value of a home that I have not mentioned.
Some ideas mentioned above are testable. For example, I was going to mention global warming but a recent paper about house price declines in California observed that the decline is greater in central California than along the coast which is contrary to what would happen to house prices along the coast due to rising sea levels due to global warming. See the paper by OFHEO, "Recent Trends in House Price", pages 4 and 5 and note 6 at http://www.ofheo.gov/media/research/pricesandfinancing.pdf. [The Office of Federal Housing Enterprise Oversight (OFHEO) no longer exist and I am unaware of an updated weblink to the paper.]

The point of this post is that to most economists who believe in economic value, efficient markets and rational expectations, the current decline in home prices is a rational response to a change in expectations about the value of homes. If there were not this belief that current homes are fairly valued, then buyers would be buying up and warehousing the depressed priced homes, the foreclosed homes and abandoned homes. The fact that buyers are not rushing in shows that the current prices of homes are fair and homes are not undervalued.