Are we in a housing bubble?

About half of homes in the UK, US & most parts of the western world are selling above list price. People are playing lottery to see if they’ll win the honour of spending hundreds of thousands to own a property.

There’s a growing sense of unease. Renters at the lower end of the market have seen their rents rise in some places even as they’re more likely to be suffering the economic harms of the last year. Would-be homeowners are furious as they lose bidding war after bidding war, looking for someone to blame as they watch their peers land a home and lock in a low mortgage rate. 

And homeowners are riding high for now, exhaling sighs of relief that they made it into the exclusive club and eagerly watching their wealth skyrocket, worried about what might happen to change that.

The last crisis, when a housing bubble and risky behavior by Wall Street took the blame for the Great Recession, looms large in our collective memories. And with unemployment numbers still not where we want them and the unequal economic recovery from the pandemic, the fear of another crash looms. It’s unsurprising, then, that the questions “are we in a housing bubble?” and “will the housing market crash?” saw a “tremendous increase” over the last 12 months, according to Google Search.

Prices rise and fall for assets all the time for a variety of reasons, so what makes something a bubble? Yes, housing is a scary place to see volatility (it’s the largest asset most of us will ever have), so part of this fascination with housing bubbles is people paying more attention than they might with other assets. For example, used car prices have skyrocketed nearly 50 percent over the last year, but very few people are asking if there’s a used car bubble.

Google search interest for “housing bubble” dwarfs “used car bubble”

There’s no agreed-upon economic definition for an asset bubble. And in everyday conversation, it appears to mean “prices have gone up a lot and I think they’re going to come crashing down again.”

In a way, it doesn’t really matter what we call it. There are fundamental problems in the housing market that have to be fixed and the solutions for them are relatively straightforward. Whether prices will come down, stop appreciating, or this is a new normal in the price of homes depends on public policy choices that are in our control.

What is a housing bubble?

Ask two Nobel Prize-winning economists, and the answer is blunt: “It’s impossible to know for sure whether something’s a bubble,” said Richard Thaler in a conversation with his colleague Eugene Fama.

“What’s the bubble?” Fama added. “The up? The down? The subsequent up?”

Harvard economist Robin Greenwood and his fellow researchers looked at 40 times when stock prices have increased over 100 percent and found that a “sharp price increase … does not, on average, predict unusually low returns going forward.” That is, a quick price boom does not mean an inevitable crash (though they do find evidence for the “increased probability of a crash”). This means just because prices rise really fast doesn’t mean it’s a bubble in danger of popping. 

The story of the Great Recession is still being debated over a decade later, and the smartest minds in economics have yet to figure out how to decide if something is a bubble, especially while it’s happening. That means you should be very wary of people telling you they know that something is a bubble or that it isn’t. That said, here is the case for, and against, calling today’s housing market a bubble.

The case for seeing today’s market as a housing bubble

First, prices have gone up a lot. CoreLogic’s index, a leading measure of US home prices, “recorded a 13 percent annual gain, the highest since February 2006.”

The “contagion” factor seems to be there as well, with some would-be homebuyers behaving somewhat irrationally in their desperation to get a house. People are offering to name their firstborn child after the sellers if their bid is picked; others are lining up around the block, forcing realtors to act like bouncers as “people try to cut in line,”. And roughly two-thirds of people who bought a home in 2020 made an offer on a house that they had never seen in person.

Unlike the Great Recession, credit-tightening standards mean qualifying for a mortgage is pretty difficult, so if we are witnessing another housing bubble and it does pop, there are likely to be fewer people who are at risk of default.

This isn’t a situation where a ton of people have mortgages that they won’t be able to pay off — the marginal homebuyer is wealthier and more secure than in the lead-up to the Great Recession.

The case against seeing today’s market as a housing bubble

The case against calling this a bubble is pretty straightforward. Prices are rising primarily due to low supply. That’s paired with the demographics of the nation, which predict a huge surge in demand as millennials age into the prime home-buying years.

Another reason so many nontraditional markets have seen home price appreciation is because of remote work. It allowed a small portion of the population to relocate to cheaper markets where they can easily outbid locals. 

The stickiness around remote work will play a big role in whether this is a permanent change.

This is why, for the average person, figuring out the terminology around bubbles shouldn’t be the biggest concern. The biggest concern is that when you want to move to a new job, there might not be a house to buy or a place to rent for you and your family. That when your kids grow up, there will be no homes available nearby for them to live in. That when your parents want to downsize, or are unable to afford their mortgage on a fixed income during retirement, they’ll be forced to move out of their community because there are no available places to live.

This is a crisis of our own making. The housing frenzy that accompanies the current moment is a byproduct of turning an asset that could be widely available into a scarce one. It’s up to local, state, and federal authorities to reverse that trend quickly or face the consequences.


Nazrul Hoque – 01 July 2021