Housing crash that devastated U.S. real estate misinterpreted, report says

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Housing skeptics argue that Canada’s real estate frenzy is a bubble that will inevitably burst, just as the 2007 US property boom happened in spectacular fashion. But what if skeptics are reading history wrong?

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America’s experience has been widely misinterpreted over the past two decades, according to recent research by three economists. one in paper With 2020 Hindsight entitled Housing Cycles of the 2000s, researchers report that while US home prices in 2006 were undeniably fading, they weren’t the outright speculative madness that’s commonly believed.

The strongest evidence for that view is that the prices of US homes fell sharply from 2007 to 2012. Looking back during the entire past 20 years, the pattern is “not boom-bust but boom-bust-rebound,” write Gabriel Chodorow-Reich of Harvard University, Timothy McQuaid of the University of California, Berkeley, and Adam Gurren of Boston University. .


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To put it another way, bubble-era speculators were undoubtedly ahead of time, but they weren’t necessarily wrong. The housing crash devastated home prices for a few years, but it didn’t leave them in a permanent hole.

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The S&P/Case-Shiller US National Home Price Index is now above its bubble-era peaks, even after adjusting for inflation. This is not what one would expect to see that the boom-era boom of prices was based on nothing but runaway sentiments and winning debt, as the big short And other popular histories of the housing craze suggest.

Instead, according to the researchers, fundamental factors have played a bigger role than previously thought. They found that the cities that boomed the most during the bubble period between 1997 and 2006 also had the most movement – ​​but the strongest rebound occurred after that.

This suggests that the bubble-era buyers were, on the whole, not bunches of idiots. These investors were right in thinking that the long-term outlook for real estate has radically improved in many cities.

Where these buyers went wrong, they were too optimistic about the short term and were taking on too much debt as a result. This led to financial fragility and a crash that pulled home prices below their original value. However, once that blow had passed, strong fundamentals powered an impressive rally.

What were the basic principles, starting in the late 1990s, to drive this trend? Among other things, superstar cities such as Seattle, San Francisco, San Diego and Boston became magnets for well-paying jobs in finance and technology. As well-educated, upwardly moving families flocked to take advantage of those jobs, they ran against the limited supply of housing.

Viewed this way, a significant portion of the American housing frenzy of the early 2000s can be seen as a reflection of supply and demand rather than a spontaneous burst of enthusiasm or loose lending conditions. In fact, the researchers found that they could predict the shape of the boom-bust-rebound cycle in various US cities with a model that looked at some fundamental factors such as housing supply, local income, and amenities.

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The researchers tip their collective hats to the work of the late Charles Kindelberger, a noted professor of economics at the Massachusetts Institute of Technology, who wrote Frenzy, panic and accidents, an excellent work on financial crises.

Pro. Kindleberger argued that mania usually begins with a real improvement in fundamentals. This change excites investors, who then become over-optimistic and bid prices go unreasonably high, eventually leading to a crash.

The challenge for investors (and for policy makers) is to separate genuine improvement in fundamentals from speculative fever – rational enthusiasm from the irrational, so to speak.

“Of course, the vision is 20-20,” write the researchers. Separating over-optimism and fundamental factors, and how much each is responsible for any increase in housing prices, is nearly impossible when rapid changes are taking place. But they suggest policymakers should “heed Kindleberger’s statement that essentially all hysteria is based on fundamentals to some degree.”

Canadians may want to consider this notion. Canada’s cities that have reaped the biggest gains, such as Toronto and Vancouver, share many features with American superstar metros – they are centers of financial and technology jobs with limited supplies of housing.

Rather than dismissing home prices in these cities as speculative bubbles, it might help to look at them through a Kindleburger lens based on fundamentals, perhaps with a dash of over-optimism added. To be sure, a short-term correction is possible, but, if US experience is any guide, bringing prices back in these centers over the long term will require a change in fundamentals – such as a large increase in housing units.

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