Whence the Housing Bubble?

I have recently written that there are certain key indexes and ratios derived from Austrian business cycle theory that help us discern the development of bubbles in various sectors. As Mises wrote: “Only theory, business cycle theory, permits us to detect the wavy outline of a cycle in the tangled confusion of events.”

Jeff Peshut, an institutional real estate investment manager, has been kind enough to share with me a chart that he has developed that is useful in detecting a bubble in the housing market. His chart below shows the ratio of the average existing home sales price to average household income. The long term average (LTA) of this ratio has been slightly above 3.0. At the beginning of 2001, however, it began to rise rapidly, reaching a peak 33 percent higher than the LTA during 2005, and then declining precipitously back to its LTA during 2008.

Peshut’s chart also shows that, as of the beginning of 2012, Fed monetary policy had been unable to restart a bubble in the housing market unlike it had done in financial asset, farmland, and commodities markets. In fact housing prices were still falling both absolutely and in relation to household income. This is apparently beginning to change as it has recently been reported that the S&P/Case-Schiller Home Price Indices “showed that all three headline composites ended the year with strong gains. The national composite posted an increase of 7.3% for 2012. The 10- and 20-City Composites reported annual returns of 5.9% and 6.8% in 2012.” In contrast, national income rose by 4 percent and disposable personal income by about 2 percent year over year in 2012.

Average Home Price To Household Income Ratio 02-13-1


  1. What we must understand about the increase in housing sales is that it is mostly purchases of private homes as rentals. Many people became overextended and could not support the cost of their home. Many of these people have been forced to short sell their homes or enter into foreclosure. The owner then would have to rent a home because their credit record would not allow them to qualify for a new home. Those who purchase these short-sale homes or foreclosed homes can turn around and rent them to the very home owners who lost their homes at a rental rate they can afford. Much of the appearance of a new housing bubble is not real.

    • Yep, I must admit, I recommended this as a solution a few years ago. Although, imperfect, it’s as close as a win-win as you’re gonna get in this messed up time.
      It goes like this: Can’t make the mortgage vig, ok, I’ll buy your house (or you foreclose, whatever). You stay right there and now you pay rent to me.
      No trauma with the kids changing schools, etc. No damage from pissed off evictees, no wounded pride, etc.
      Also no need for govt. intervention.
      Like I said, the best of a bad situation.

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