Tuesday, 10 November 2009

Housing Bubble : The Demonstration

The last few days I read a nice research paper:
"The housing price boom of the late ’90s: did infl‡ation
targeting matter? by Sébastien Frappa and Jean-Stéphane Mésonnier, June 2009"

From that I extracted two critical information that fit pretty well with the current context.

"As households are confident that the central bank will not need to raise short term interest rates in a foreseeable future because they think that inflation is on check, they will tend to believe that observed and projected growth rates in housing prices are sustainable.

Since their expectations of low future interest rate should increase mechanically their assessment of the present value of houses considered as assets, they will be more willing to buy housing property at high current prices (compared to historical records).

Finally, they will be less reluctant to finance their home acquisition through mortgage contracts with adjustable rates, which are generally cheaper than fixed rate mortgages."

This is exactely what is currently hapenning in Finland.

"Since 1970, nominal housing price growth has fluctuated widely in developed economies with four expansionary phases:
-in the early and late 1970s,
-in the mid to late 1980s and
-from the late 1990s to the mid-2000s
and three slowing phases:
-in the mid 1970s,
-the early 1980s
-the early 1990s.

Note that, while housing price busts are normally characterized by a significant drop in real house prices, nominal house price defation is rare and was associated in the past with episodes of severe economic downturns, such as the recessions in the early 1990s in Finland, Norway and Sweden.


Anonymous said...

The conclusions seem to tell a story known by all. What worried me is actually the story may not be that simple as the conclusions. Only interest rate plays the role for the ups and downs of housing price? Fairly say, I don't believe such a lie. If inflation would be 100% and the housing nominal price rises also 100, people would still rush to buy even through the loan interest is 95%. So, the oversupply (and the opposite) of m1-m3 seems to play a much, much bigger role. Currently, the housing price rise is because of the oversupply, IMHO.

By the way, it is interesting to read the other conclusion:

"...while housing price busts are normally characterized by a significant drop in real house prices, nominal house price deflation is rare and was associated in the past with episodes of severe economic downturns..."

Dose this shows it is correct to buy real estate even now since the nominal house price deflation is rare? If so, comparing with holding cash, buying real estate can protect the property value better usually. Am I wrong here? If yes, why?

HousingFinland said...

You are raising very good remarks.

With regard to the second paragraph, I though it was important to extract it from the doc as it is an important information.

The idea that price never deflate except in major crisis may be something from the past.

But first, the current crisis is a very severe one and from the Finnish point of view, this could be even worse than 1990 i.e The reason is that by 1996, it was all over. It really lasted 4-5 years thanks to particular industry giants, to the health of the global economy, to the low level of debt compare to today and buyoant consumers and credit appetite.

In fact prices have gone continously higher for many reason since 1950... before 1950, We have had 2 world wars that wiped out lots of dwellings(see Berlin) and 1950 you had a massive and historical baby boom.

However since then the birth rate plumetted and a vague of retiree are ready to fall in the Finnish country like a tsunami (any detector in place?)

with regard to interest rates, once I made chart (got to find the article)that demonstrate clearly that when interest rates fall or stay low , housing price does not move much, in fact they tend to correct -on a medium period - (you always have bumps of course).

Now the question can central bank reflate asset prices without triggering an inflation armageddon and triggering social and industrial disturbance?

Anonymous said...

Housingfinland's Biased Poll:

House Prices will drop into 2010 by: -5, -10, -30, -50%

So, this poll assumes for sure price will decrease (Housing finland's opinion)- no room for differing opinion.

Can't you add option for increase in 2010 as well?

+5, +10, +30, +50%

then we can see real opinion.