How high are real house prices?

Published in Real Clear Markets.

“Home prices are back to near-record highs across the U.S.” declared the Wall Street Journal in a June 1 front-page story. They are, indeed, when measured in nominal terms.

The Case-Shiller National House Price Index for the first quarter of 2016 is as high as it was in September 2005, in the late-phase frenzy of the bubble. That was only nine months before the 2006 bubble-market top, which as we know only too well, was followed by collapse. In addition to reaching its 2005 level, the National House Price Index has gone back to well over its trend line—more than 11 percent over. All this is shown in Graph 1.

So the Federal Reserve has gotten its wish for re-inflated house prices (although not its wish for robust economic growth).

Are high house prices good or bad?  That depends on whether you are selling or buying. If you are the Fed, it depends on how much you believe that creating asset-price inflation leads to “wealth effects” that improve economic growth.

Of course, besides asset-price inflation, the Fed truly believes in regular old inflation. It has often announced its intent to create perpetual increases in consumer prices. Since the bubble top in 2006, the Consumer Price Index has increased by an aggregate of 17 percent.

This means that house prices – measured in real, inflation-adjusted terms – look different from Graph 1. Real house prices are shown in Graph 2, expressed in constant 2000 dollars. They have still gone up a lot in the last few years, but not as much as in nominal terms. They have matched their level from October 2003, rather than September 2005.

In October 2003, house prices were clearly inflating: they were half way, but only half way, up their memorable bubble run from 1999 to 2006. Do we remember how happy so many people were with those high house prices?  Do we remember that the Fed Funds Rate had then been reduced to 1 percent?  That the Fed was thinking of wealth effects?  At the time (in January 2004), the Wall Street Journal published an article entitled, “Housing Prices Continue to Rise.” It reported that “the decline in interest rates has made housing more affordable,” that forecasts were for “the house party to rage on in 2004”—a good forecast— and that “few housing pundits see much risk of a national plunge in house prices”—a terrible forecast.

In 2003, was it time to pay attention? It was. Going forward from here, can we imagine what house prices would be with genuinely normalized interest rates? In mid-2016, can the pundits see much risk of anything going wrong?