The Fundamentals Behind the Housing Boom

The current edition of the Chicago Fed's Economic Perspectives publication carries a marvelous article about the fundamental drivers about this massive housing boom we're in. In short: Don't blame the housing bubble on a couple years of cheap interest rates. Rather demographics, technology, and financial market innovation have converged to give us a long boom.

I agree wholeheartedly with the basic thesis of the work - that is, Americans (western economies generally) are wealthier and the costs of acquiring homes has gone down, therefore home ownership and home demand has increased. This uber-capitalist orientation strikes close to my heart and echoes the work of David Malpass at Bear Stearns and the folks at GaveKal Research. Both of whom I've referenced before.

Here's a particularly insightful point, one that runs counter to most real estate bubble headlines these days.

The dramatic rise in residential investment and homeownership has coincided with equally dramatic developments in the mortgage market. Over the past ten years to 15 years, the mortgage market has developed substantially in four areas. First, technological progress has reduced the cost of approving a mortgage under a standardized set of lending guidelines, in part by allowing more precise measurement of a borrower’s credit risk. Second, mirroring developments in financial markets more generally, many new kinds of mortgages have become available. Third, the secondary mortgage market has grown and matured so that many kinds of mortgages can now be packaged and sold as mortgage-backed securities. Fourth, the mortgage market has become more specialized, as firms concentrate on different pieces of the market, including origination, servicing, and securitization.

Of these developments, the second is most important for our argument. We think that the main impact of the other three developments is to increase competition and lower transactions costs. Also, the development of the secondary mortgage market probably improved the risk–return tradeoff between mortgage-backed securities and other financial instruments.

A refreshing counter point to be sure. New Fangled mortgages don't deserve the bad rap they're getting lately. Financial product innovation gives more people more of what they want; it increases competition and reduces costs. Attempts to "protect" consumers from these products will result in less efficiency and higher costs for everyone involved. Proceed with caution.

One beef I have with the article. The authors shrug off recent lax interest rates as a "cause" of current housing market. Rather, they say, a booming economy is a factor. But a booming economy leads to feelings of job security, which is indeed a big driver of housing demand. That's why I fear a coming recession as a pin prick in our lil' housing bubble.

Thanks to Inman News for the link

Update August 28: I notice Jonathan Miller at Matrix has his comments on the report as well. Summary: Duh, of course low rates fueled the boom.