Accelerated productivity rates, and not irrational
expectations, were the main force behind the rapid appreciation in housing
prices in the U.S.
That's the argument of a paper published Thursday by the Federal Reserve Bank
of New York, by economist James Kahn. The research tilts against the commonly
held view that the sharp run up in home prices seen into 2007 was a bubble that
never should have happened.
"Changing economic fundamentals - specifically, swings in labor productivity,
or output per hour of work - played a significant role in the movements of
housing prices," he wrote. "These productivity swings helped determine the
price of housing through their effects on income growth and long-term income
expectations - factors that directly influence what consumers are ready to pay
for housing and what mortgage providers are willing to lend."
Kahn argues that rising productivity rates boosted incomes, growth and
expectations of future activity, but also helped create "a sense of optimism"
that caused people to be willing to pay more for housing. It also influenced
what sort of financing banks were willing to offer homeowners.
When productivity rates began to slow in 2007, a lot of the optimism rightly
wilted, and thus, housing prices began their descent.
Much of what Kahn argues stands against the prevailing assessment of what's
happened to housing markets over recent years. Most economists believe, in a
view shared by most Fed officials, that housing prices were indeed a bubble:
Home buyers had unreasonable expectations of how much their homes would
appreciate, and a sea change in the way Wall Street created and financed
mortgages created a game of musical chairs that allowed prices to rise for a
number of years.
But as soon as trouble brewed - it started in mortgages for subprime
borrowers - the game was over. House prices in many parts of the economy
crashed, foreclosures shot higher, chaos and pain reverberated through the
financial system, and the economy fell into its deepest recession since the
Great Depression.
With an end to the recession coming into view, it's still an open question
whether the housing market has stabilized, both in terms of prices and selling
activity. Some say yes, but without much conviction.
Kahn doesn't disagree that other factors had an impact on housing. But he
argues his model shows a pretty strong correlation between productivity rates
and housing prices over the last 45 years.
"The current housing crisis stemmed in large measure from a change in
economic fundamentals and was only exacerbated by credit market conditions,"
Kahn wrote. Moreover, what some believe were declines in credit standards may
in fact be justifiable given what was known then about the economy.
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