Housing Crisis: Housing Bubble or Lending Bubble?

by: Anonymous Investor..

The increase in home prices cannot be explained by fundamental factors, such as rising incomes and population growth. The growth in income over this period has not been especially rapid. The rate of income growth is considerably slower than in the years from 1950 to 1973, when the rise in home prices just kept pace with the overall rate of inflation. The growth in population over this period has not been especially rapid. The most rapid growth in the number of new households actually took place in the 1970s and early 1980s, when the huge baby boom cohort was first forming their own households.

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Most importantly, there has been no significant increase in rents, which would be expected if the run-up in house prices were explained by the fundamentals of the housing market. Rents and home sale prices have always moved closely together, since families can freely switch between renting and owning depending on the relative prices, and landlords can sell off rental property if home sale prices rise substantially relative to rents. Rents had increased somewhat more rapidly than the overall rate of inflation from 1998 to 2002, and are currently rising again. However, these small increases in rents compared to the large increases in home prices, could indicate that the run-up in house prices is not being driven by fundamental factors in the housing market.


Lon Witter, founding partner at Witter & Westlake Investments, recently pointed out that "by any traditional valuation, housing prices at the end of 2005 were 30 percent to 50 percent too high."

The biggest difference between the recent run-up in home prices and the one in the 70s is the financing of these home purchases. In the 70s home owners owned roughly 68 percent of their homes, whereas today they only own 57 percent of their homes.

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However, as the chart below shows, only the strong price increases in the recent years prevented that home owners lost more of their homes.

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In recent years home owners seem to have used their homes for financing their consumption needs as they have extracted large amounts from their home equity.

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The strong increases in house prices and historical lows in mortgage rates have definitely fuel this evolution. The result is, that 73 percent of households total liabilities are currently mortgages.

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If substantial price decreases in the coming months cause a free fall in housing prices, which would be the direct consequence of a housing bubble, the data above would suggest, that there could be a big problem in outstanding mortgages as borrowers will get into financial difficulties.

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