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U.S. Economy

Don't Get Your Hopes Up About Home Prices

Incomes aren't likely to soar, and lending standards aren't likely to fall.

Our long national nightmare is over. After 10 years, the Case-Shiller home price index is just a smidge above its previous peak, from July 2006. That was the longest sustained dip in national home prices in decades, and its effects on American citizens, and the economy, have been both deep and widespread. 1

Of course, the Case-Shiller index uses nominal prices, so when you adjust for inflation, we’re still below the peak. Still, it’s something of a mystery why prices have recovered as far as they have. They’ve substantially outpaced income growth since the market’s bottom in 2012. Home prices aren’t an asset class that can indefinitely grow wildly out of proportion to incomes; they’re too large a component of household spending, too big a part of the economy to keep growing at a rapid clip even when other things aren’t.

Housing Is Back

The Case-Shiller index of (nominal) home prices in the U.S.

Source: Bloomberg data

So are they due for another correction? Your forecast depends in part on how important you think various factors are in the recent run-up:

  • Overcorrection after the crash: After asset bubbles, markets often overcorrect in the other direction. The 2012 trough may have represented an underpricing, in which case, it would make sense for prices to grow faster for a few years.
  • Low interest rates: In theory, interest rates shouldn’t make much difference to the price you’re willing to pay for a house. After all, low interest rates usually mean lower expected inflation, so while you pay less now, the real value of your mortgage will not fall as quickly as it would with higher inflation. People are not necessarily good financial theoreticians. They tend to look at the monthly payment, not the price of the house. So the lower the interest rate available, the more they are willing to spend.
  • Undersupply of housing: Housing starts were badly depressed by the Great Recession as rising standards both made it harder to finance new development and contracted the market for new supply. Over a period of years, that meant that the supply of homes for sale fell, and as incomes and credit reports recovered from the 2008 disaster, rising demand put pressure on prices.

If you think that the story is “correction from the original overreaction,” then maybe current prices are relatively reasonable. If you think it’s interest rates, then what you think will happen depends largely on where you think interest rates are headed. And if you think that this is mostly a story of rising demand pressing up against limited supply … well, that’s the sort of problem that markets generally fix, as higher prices attract greater supply, and prices fall back to their market-clearing level. (Complications may apply.)

On the other side of the ledger, lending standards are holding down housing prices: While interest rates are low, lenders are demanding higher down payments and better credit histories from borrowers than they did in 2006. If those standards were to slacken, prices would have considerable upside potential (though the market would also be more vulnerable to a crash, because small down payments and poor credit histories are a sign that buyers are going to have trouble affording the house).

There’s another factor that isn’t currently providing a huge boost to housing prices, but might: real income growth. If Americans’ incomes started ticking upward at a faster clip (not overlikely, given how long this expansion has gone on, but theoretically possible), then these home prices would be justified, perhaps even undervalued.

Your assessment of the market, and its future, thus depends on which factors you think are pushing up home prices (my take: all of them), and how you think lending standards and economic growth might evolve. I’d guess that some of the upward pressure will slacken and that there is unlikely to be either income growth or easing credit standards to help offset the decline.

On the other hand, if there’s one economics lesson drilled into me at the University of Chicago, it’s that no one can set prices better than the market can. I wouldn’t wager any large sum on my guess.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

  1. Contrast with the recovery by the end of the 1930s, at which point U.S. home prices were still about a third below their pre-Depression peak.

To contact the author of this story:
Megan McArdle at

To contact the editor responsible for this story:
Philip Gray at

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