WASHINGTON - July 29 - A new study from the Federal Reserve Bank of New York wrongly concludes that the run-up in home prices over the last few years is not attributable to the existence of a housing bubble. A new report entitled Too Much Bubbly at the Fed?: The New York Federal Reserve Boards Analysis of the Run-Up in Home Prices by Center for Economic and Policy Research (CEPR) Co-Director Dean Baker, finds that available housing market data contradict the Fed study's explanation for the recent run-up in home prices. The CEPR report comes out as the Census Bureau releases its second quarter 2004 Housing Vacancy Survey today.
Since the third quarter of 1995, home sale prices have risen by more than 33 percent after adjusting for inflation. In the regions with the largest increases in prices, the real increase has been more than 50 percent over this period. This run-up in home prices has created almost $4 trillion in housing wealth compared to a situation in which prices had simply kept pace with inflation.
The New York Fed questions whether this run-up in home prices can be attributed to a housing bubble. The novel part of this study is the effort to attribute the run-up in prices to quality improvements. The study relies on the Census Bureau's constant quality new construction price index as a measure of inflation in housing prices. This index shows only a slightly more rapid pace of inflation in housing prices than the overall CPI. The Fed study argues that the difference between the Census index and the more commonly used House Price Index (HPI) is attributable to the failure of the HPI to pick up quality improvements.
If the huge run-up in home prices in recent years could be explained by a rapid pace of home improvement, then spending on home improvements should have been very high in these years. Yet the opposite is true. Census data show that spending on home improvements, relative to the value of the housing stock, has been lower in the years of the run-up in home prices than it was in the early nineties, when home prices were not rising relative to inflation. This suggests that a more rapid pace of quality improvement cannot explain the run-up in housing prices shown in the HPI.
Further, annual spending on home improvements is equal to less than 1.0 percent of the value of the stock of residential housing. Changes in the size of this spending are an order of magnitude too small to explain increases in the value of the housing stock that have averaged more than 8 percent annually over the last eight years. And the areas that have experienced the most rapid rate of quality improvement, using the methodology in the Fed study, are not the areas that have seen the largest increases in spending on improvements, according to the Census Bureau's data.
The number of vacant units is now increasing at a 750,000 annual rate. This is more than one-third of the rate of housing construction and more than 50 percent of the rate of annual absorption. This growth in vacant units can be explained only by a speculative bubble. It is not clear what alternative explanations could be plausible. The Feds study is contradicted by the available data and does not provide any credible reason to question the existence of a housing bubble.
The full paper is available at: http://www.cepr.net/publications/fed_housing_bubble.htm
Or in PDF format at: http://www.cepr.net/publications/fed-housing%20bubble.pdf