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June 3, 2005



PAUL GIGOT: Welcome to THE JOURNAL EDITORIAL REPORT. The median price of a home in the United States -- the median price -- has now passed 200 thousand dollars for the first time in history. That's the kind of fact that makes millions of American homeowners happy, and makes others worry that something's got to give. Most Americans own homes, and for the vast majority it's their single most important asset -- so all the talk about a housing bubble that may be about to burst can be frightening. Joining me to discuss all this are: Bret Stephens, a member of THE WALL STREET JOURNAL editorial board; Rob Pollock, a senior writer for the editorial page; and Brian Wesbury, the chief investment strategist of Claymore Advisors, who has written often for the JOURNAL editorial page.

Let's begin by trying to define what people are talking about when they talk about a housing bubble. A housing bubble can form when prices are driven up by favorable economic forces. Today, increased buying power, fueled by low interest rates, continues to foster record demand for houses. Cheap money has made homeowning widely affordable: 69 percent of Americans now own their own home, more than own stocks. And they have done better. The median price of an existing home rose more than 15 percent in just the last year. But should interest rates go up, adjustable rate loans that helped people get into those bigger and better homes could become very expensive. Owners could become sellers. Expensive money would mean fewer buyers. Supply would exceed demand. Prices could plummet.

By some estimates, the housing sector accounts for 25 percent of all activity in the economy, construction nearly five percent by itself. Bursting a bubble that large just might be big enough to send the economy into a recession. So far, however, long-term interest rates are holding steady. So, is there a bubble? Many say no, there is no bubble. Until it bursts.

I asked each of our panelists to look at all the statistics and choose one that struck them as particularly important in understanding the issues. Rob, you start with price.

ROB POLLOCK: Yeah, well we've got a very interesting chart, and what it shows is the average inflation-adjusted home price in the United States since 1890. And what you see is, that it bumps along in a certain range for awhile, but what you also see pretty dramatically at the end of the chart is that the average inflation-adjusted price is at an all-time high and it's rising rapidly. Now, that doesn't necessarily mean there's a bubble. There could be changes in the supply/demand fundamentals to justify this. But I'm hard pressed to think of what they might be, what kind of changes could justify double-digit year-on-year increases in many markets, as we've been seeing.

PAUL GIGOT: In L.A., Los Angeles, in just the last three years, there was a 17 percent increase in 2002, 19 percent increase in 2003, and 23 percent increase in 2004. This does have -- there are regional variations though, aren't there? It's concentrated in West Coast, East Coast, Florida, not as much in some other markets.

BRIAN WESBURY: That's right. There are regional differences, and there are even differences within a community as well, if it's on the coast or if it's off the coast a little bit. There's lots of factors that are driving these prices up. One is the fed. The fed has been holding interest rates very, very low. Another one is very interesting, and that is the demographics of our country. We have an aging population.

PAUL GIGOT: I think we have a chart that illustrates that.

BRIAN WESBURY: Right. Fifty to 64-year-olds in the United States -- just that age group, 50 to 64, there were 35 million in this group back in 1996, there's 49 million in this group today. It was 13 and a half percent of the population, today it's 17 percent. Eighty percent of that group owns their own home -- as you just said, 69 percent of the nation. So as that group gets larger, as our nation ages, we're going to own more homes. And I think that's one of the things that's happening in the housing market today.

ROB POLLOCK: If I could interject with a question for Brian. The supply of real estate is not inelastic in those parts of the country. That is, there's space to build new houses, to meet new demands. So if it's the demographic factors that you cite that are causing the rise, why is it that, if in most of the country you can just build new houses to meet ...?

BRIAN WESBURY: Well, you can in most of the country. That goes back to this local area bubble issue. Well, there is only so much beachfront property in Santa Monica. So if all those people are retiring as they age, and they want beachfront property, then that's going to drive those prices sky high.

BRET STEPHENS: Yeah, and I mean look, when you look at where the biggest rises are happening, often you see that there are perfectly good reasons why prices are going up. Prices are going up in Manhattan because it's an attractive place to live, the city's never been safer, and it's bringing in capital from all over the United States and from abroad. And as you said, things like beachfront are not inelastic. Take Nantucket Island, a premier summer resort in the coast of Massachusetts. Half the island is given over to conservation. There are only so many beachfront properties left. There are only so many buildable lots left. So prices have gone up in the last 10 years. The average price of a home has gone up from about 400 thousand to about 1.6 million. Someone from the outside might say, hold on, there's a bubble. But really, it's an attractive place to invest.

PAUL GIGOT: But there's another element here, and that is most Americans live in their homes. But now increasingly we're seeing according to the National Association of Realtors -- that 23 percent of all home purchases in 2004 were for investment, not for living in, and that 13 percent of homes are vacation homes. How does this change the dynamic, when you're talking about real estate as investment, and an element of speculation?

BRIAN WESBURY: Right. Well one of the things that's happening there, too, is with the aging population, with a great build-up in wealth over the last 20, 25 years, two-home families are today like where we were 40 years ago with two-car families. So more and more people own two homes. So the demand has also gone up for that reason as well. So we're in this interesting environment where easy fed policy, demographics, and wealth are all pushing together.

And there's one final factor, I think, that's doing this, and that is that we changed the tax rules on housing back in 1997. Housing is now the least taxed investment, basically, that a consumer can make.

PAUL GIGOT: Describe how that tax rule changed.

BRIAN WESBURY: Right. Well, there's two things. First, you can write off the interest you pay on your mortgage, which automatically is an advantage.

PAUL GIGOT: Even on a million dollar home?

BRIAN WESBURY: That's right. The second thing is that it used to be, all during the fifties, sixties, seventies, eighties, that you had to roll over a home when you sold it, roll any profits you received into a new home, or you would owe taxes on that. You were allowed a once in a lifetime deduction against taxes of 125 thousand dollars, and you had to be over 55 to take it. In 1997 that was changed. If you live in a home -- a couple lives in a home -- for two years, you can now sell the home, take 500 thousand, up to 500 thousand dollars in gains tax free.

PAUL GIGOT: That's amazing. Because you can't do that if you buy a car, you can't do that if you invest in General Motors stock or General Electric stock. So you're really talking about an industry that is one of the most heavily tax-favored in the entire economy, maybe the most tax-favored.

BRIAN WESBURY: That's right. And look what happened. Art Laffer always used to tell us, when you tax something less you get more of it. And that's exactly what had happened. And so in terms of the demand curve, you've got wealth and taxes and monetary policy, and aging population, all moving to lift the demands.

BRET STEPHENS: Yeah, I mean, and just look at the places where people are buying. There's a bubble in Florida. Well hey, this year the first generation of baby boomers is turning 60. Gee, they're moving to Florida. It's not entirely surprising.

In other places in the market -- in North Carolina, in Houston -- prices are actually -- in North Carolina prices have been going down in some places. In Houston the market has been flat. So I think you're absolutely right, that it reflects not only a generational shift but also a normal, rational, geographic shift.

ROB POLLOCK: But I'm not sure I buy the demand explanation. Look, when families went over to having two cars, as far as I know the average inflation-adjusted price of a car didn't go up, because Detroit, they will have made more cars to supply the market. And again, in most parts of the country, more real estate can be supplied, if there's more demand. So what's justifying ...

BRIAN WESBURY: And this is where we're now going to get into a little bit of arcana about I think one of the things that's happening in the country today is that we do see inflationary pressures. And if you go back and you read the original monetary theorists, what we don't know is when the fed injects lots of money into the economy, exactly where it will show up.

PAUL GIGOT: The Federal Reserve Bank under Chairman Alan Greenspan.

BRIAN WESBURY: That's correct. Today under Chairman Alan Greenspan I believe they've been holding interest rates too low, adding a great deal of liquidity to the economy. And where it's mostly showing up is in home prices, and that's one of the reasons. What's happening is, is that the value of the dollar is falling relative to home.

PAUL GIGOT: We should say that this was a deliberate economic strategy by the federal reserve. After the bursting of the stock bubble and the dot com bubble in 2000 and 2001, they said, wow, to avoid going into recession what we need to do, take interest rates down, inflate the consumer sector. And one of the ways to do that is to keep them happy, is to keep interest rates low, and allow them to refinance, take money out of their homes to boost consumer spending. This has worked beautifully. But you're making the point that they stayed too loose on money supplies for too long, and that has now boosted the real estate prices in an artificial basis. I hear you saying that at least a little bit.

If you look back at the history of home price bubbles, the 1970s was one big increase. That was an era of great inflation. Now we have probably a more modest inflation this time, but nonetheless you think still real.

BRIAN WESBURY: Yes, I do. And that's one of the things that's interesting. Typically when you see housing prices go up, you will see gold and other commodity prices go up. Land -- real estate, farm land -- all of it's going up. It's not just housing, too. I mean farmland prices have gone up. So that happened in the seventies, that's happening again today. And that's typically a sign of a very easy monetary policy, or an inflationary monetary policy.

BRET STEPHENS: But I also think it's important to point out, I think there's a danger in talking about a bubble, or in thinking about a housing bubble in the same way that there was a NASDAQ bubble or a high tech bubble.

PAUL GIGOT: It's not the same.

BRET STEPHENS: It's not the same thing, not least because real estate isn't something you trade overnight, in instantaneous transactions. Any kind of real estate transaction is probably going to take between 30 and 60 days. People go to a property, they look at it, they think about it. It's a much more studied investment. It's a much more rational investment than the kinds of Internet start-ups that had huge market caps during the late 1990s and then came crashing because they were based on nothing. We're talking about real assets.

BRIAN WESBURY: And not only that, you get a service from it. You live in the home, it provides a service to you. So there's an earning, there's a dividend, so to speak, from the home, whereas none of the dot com stocks had a dividend. So there's lots of ways to separate those two. I agree with you, Bret. It's not the same.

PAUL GIGOT: Alan Greenspan recently said, after months of saying -- years, really, of saying -- there was no problem in real estate, immigration, demographics, all the arguments. He said suddenly, "There's some froth in the market." What was he trying to do with that? Was that a subtle admission, do you think? The federal reserve chairmen never admit mistakes. They just describe new problems. Do you think that this was a tacit admission that maybe they have been too easy with monetary policy?

BRIAN WESBURY: I read it that way. What was interesting is that the bond market did not. When Alan Greenspan talked about froth in the housing market, long-term interest rates came down as if the market thought, well, if he's describing this problem then that means the fed won't raise rates to cause the bubble to burst. When in fact, I would read it the other way into saying that if he's talking about froth then that's going to make the fed and Alan Greenspan more willing to raise interest rates to keep it from getting out of control.

PAUL GIGOT: Remember in the nineties when Mr. Greenspan said irrational exuberance existed in the stock market, and that was about half-way through the ...

BRET STEPHENS: Yeah, that was in 1997. There was plenty of irrational exuberance left in the market.

BRET STEPHENS: He waited for a long time before tightening rates to stop that.

PAUL GIGOT: Is he going to have better luck this time in talking this foam off of the cappuccino cup, as you described it?

BRIAN WESBURY: Yeah, that's right, when I think of froth I think of a cappuccino, I think of a realtor's office. But nonetheless, I think the fed will continue to raise interest rates at a measured pace, and they will continue to view this froth and hopefully it won't get more bubbly in their minds, and they won't have to accelerate. I think that's their goal.

PAUL GIGOT: One thing we saw was the decline of the NASDAQ, the tech stocks. It moved from a high of five thousand down to below one thousand. And of course the stock market is a national market in a way that real estate isn't. You're not going to see those kinds of declines, are we, Bret, even if we get a leveling off or a decline in some real estate markets?

BRET STEPHENS: No. And Alan Greenspan doesn't seem to think so. Where we might see declines is where there've been speculative purchases Florida, places like Malibu, San Diego, where prices have been skyrocketing. But there's plenty left in the rest of the country, which I don't think is going to really be affected by it, particularly by people who've owned homes for a long period of time. I mean, there might be a slight dip, but I don't think that Jack and Jill Smith are really going to suffer here.

PAUL GIGOT: Are you as sanguine about that, Rob?

ROB POLLOCK: I certainly think that in some markets -- New York, particularly -- that there's a possibility for an S&P 500 side decline, which is not nothing. It's about 40 percent. And there's historical precedent for that. That's what happened in the early nineties, a bear market in New York real estate. And there's no reason to believe that can't happen again.

BRIAN WESBURY: I would argue that the times in history when we've seen big declines in housing prices or housing activity has been serious recessions in the country. And I don't see one of those on the horizon at this point in time. So we may be in for more froth in the future.

PAUL GIGOT: But some casualties, financial casualties, as rates go up. All right, I think we have to leave it there. Thank you, Bret. Next subject.