Magazine article Mortgage Banking

Economic Trends

Magazine article Mortgage Banking

Economic Trends

Article excerpt


In the past few years, several attention-grabbing articles have been written proclaiming the collapse of housing prices. "We think real estate is heading for a fall" proclaimed the investment strategy team of Comstock Partners Inc. in the August 22, 1988 issue of Barron's. "...Real housing prices will fall substantially" wrote Harvard economists N. Greg Mankiw and David N. Weil late in 1988. Although approaching the issue in significantly different ways, these two highly publicized articles contributed to growing concerns that home prices may decline, or at least not keep pace with inflation.

Like many flashy predictions, there is a kernel of truth underlying each of their analyses, but their predicted outcomes are likely to be highly exaggerated. Let's consider each of these articles in turn.

The Comstock article is weaker than the Harvard study. The main argument of the Comstock group is that real estate is highly leveraged and that debt loads are getting out-of-hand. They contend that home price increases in recent decades were supported by rising debt burdens and expectations of capital gains. Once prices peak, which I believe occurred in 1988, homeowners and prospective buyers will conclude that expected capital gains are inadequate to justify the debt load and prices will collapse. They emphasize that this is especially likely because real estate prices rose--with only brief pauses--for nearly 50 years. In effect, they make a "what goes up, must come down" case.

Over the years, there have been many voices proclaiming economic disaster as a consequence of rising debt. To date, these proclamations obviously have been overstated. The key to their argument is that markets are highly sensitive to expectations. If market expectations of price appreciation turn decidedly negative, softness in current prices can result as buyers hold off purchases and sellers rush to lock in previous gains. The market-clearing price under such circumstances can easily decline. It is common for real estate markets that have experienced a boom to go through such a correction and to give up part of the previous gain, but rarely all of it. After prices stabilize, appreciation typically resumes in response to fundamentals, such as income growth. The upshot is that declaring an eminent collapse in housing prices due to rising debt is not very convincing.

The Mankiw-Weil study approaches the issue from a different perspective, and one that has considerably more merit. They build their case on the widely recognized fact that the baby boom generation--those individuals born from 1946 to 1964--produced a tremendous surge in the demand for housing as they came of age in the late 1960s through the early 1980s, and that many baby boomers have now formed households and will not be a source of housing demand in the 1990s.

As a result of significantly reduced housing demand, real housing prices (i.e., housing prices adjusted for inflation) are estimated to decline about 3 percent per year, or a total of 47 percent by the year 2007. For example, if the inflation rate averages 4 1/2 percent--roughly the rate in recent years--home prices, in the estimation of Mankiw and Weil, would only rise about 1 1/2 percent per year, resulting in a decline in real home prices of about 3 percent per year (approximated by subtracting 4 1/2 from 1 1/2 percent). …

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