Are We Out of the Housing Bubble or Not?

(Sept. 8) -- Is the housing market on the road to recovery? Is real estate about to suffer from a double dip?

New York Times economics columnist David Leonhardt weighs in, and while hedging his bets -- "I can't claim to clear up all the uncertainty" -- proposes a layman's approach to sizing up the market: Do "you believe that housing is a luxury good and that societies spend more on it as they get richer? Or do you think it's more like food, clothing and other staples that account for an ever smaller share of consumer spending over time?" he asks.

If you consider housing a luxury good, you're more likely to think that prices will rise with income and homes aren't overvalued at the moment. But if you consider it a staple, like bread, then the general rate of inflation will be your guide, which suggests slower growth. For economists, the question comes down to if the past 30 years or so was a housing bubble, and if the market remains a bubble today.

Leonhardt sides with the more bullish, noting that Americans have spent about the same amount of their income on housing, about 15 percent, for the past 60 years. Meanwhile, spending on food has dropped from 25 percent to 13 percent.

"These numbers make a pretty strong argument that the post-1970 period is not one long aberration," Leonhardt writes. "As societies get richer, they do spend more and more on housing."

But Dean Baker, co-director of the Center for Economic and Policy Research, pokes holes in Leonhardt's analysis. Baker, who saw the housing bubble long before most economists, writes:

There is a logical problem in this analysis. In principle, the issue is the movement of the price of a house of the same quality, not the amount that people actually spend on housing. If the price of a house of the same quality rises in step with income, and the share of income devoted to housing remains constant, then this logically implies (i.e., there is no way around the conclusion) that the quality of housing has not increased over this period.

This would mean that the homes that people are buying today are no bigger or better than the homes that people bought 80 years ago. This contradicts an enormous amount of data and common sense. It is unlikely that anyone would seriously argue this case. Therefore, we can conclude that house prices have not kept pace with income growth.

Baker doesn't supply an adjusted figure, but his arguments ring true with a layman's observation of the market, as people bought "starter" homes or "investment" homes with hefty mortgages hoping to flip them for bigger and better homes down the road. It worked for a while, but no longer.

Read more at The New York Times and Dean Baker's blog.