Home Values Still Historically High: Does It Make Sense?

Yale economist, Robert Shiller, mentioned in an interview today that home prices have been historically flat, going back a hundred years, from 1890 to 1990. Then, he says, housing underwent one of the biggest bubbles in history, jumping almost 100% higher in real terms (adjusted for inflation). The peak was in 2006, and since then prices have dropped about 35%. Despite the drop, prices are still between 5% to 10% higher than the long run average:

What’s the obsession with averages? The natural tenancy of estimators is to look for natural tendency. The easiest first guess is to look for the long run average, and assume there’s something special about it. Maybe it’s an equilibrium point? Of all the things that people can spend their income and savings on, maybe housing takes that natural price point relative to everything else?

In order to justify prices going above a natural point we need to find drivers for change. In the case of housing, here’s just a few game changers that could alter housing demand:

• Population growth – More people means more need for housing.
• Access to capital – At no time in history have more people had more access to capital than they have in the last couple decades (think lax lending standards, and unprecedented flow of funds into new, sexy MBS instruments!)
• Public policy shifting capital into housing

Of these three big drivers for housing demand, which have gone away since the crash? The population is still growing, and households are still forming. It’s harder to get a mortgage now, especially for people without the standard 20% down payment, and who have blemishes on their credit from getting caught in the fallout of this last crash. And then there’s the government-all governments: federal, state, and local-still pushing as many people into buying homes as they can. Fannie Mae, Freddie Mac, the Department of Housing and Urban Development (HUD), and all the other agencies still exist and are still funneling hundreds of billions of capital towards housing.

So clearly, home prices shot up way too far, way too fast, but the big question is “what’s the new equilibrium?” Should prices fall back to the 100+ year historical average? Should they drop right on through the average in violent correction? Or are there legitimate economic reasons for prices to remain at an elevated level?