The Proud Duck
Friday, June 24, 2005
Housing bubble spreads like a virus
Since house prices in my immediate neighborhood have in some cases increased fourfold in 8 years (from $175,000 to $675,000), I have no problem at all announcing the existence of a real estate bubble. The fundamentals of the economy have not altered so drastically in less than a decade to justify a quadrupling of the price of an existing asset category. All booms bust, and all deviations revert to the mean. Eventually, that is. And "eventually" can unfortunately be a long time.
One effect of house-price inflation is that people who suddenly find themselves with tons of equity in their property from runups in large metro areas are fanning out into previously un-bubble-touched markets looking for "investment" opportunities, marveling at low house prices in say, Phoenix, Salt Lake City, or Visalia (low, that is, compared to Los Angeles, San Diego, or the Bay Area) and bid up prices in those places far beyond what the local economies enable actual residents to pay.
This bubble, spreading from big rich cities into the hardscrabble hinterlands, is causing people real pain by turning a basic consumption commodity into an investment vehicle.
I am an economic conservative, but what I see just screams for government intervention. Government helped create this problem, by facilitating cheap credit. Money creation is a tool that government should have in its box to mitigate panics and recessions, but as has been pointed out on this blog, the Federal Reserve's classic methods of injecting liquidity don't target it well. Instead of being used for productivity-increasing capital formation, the increased liquidity is being used to inflate the housing market, allowing people who had the resources to get in on the game in the beginning to speculate and get rich, while people who just want to purchase a house for its traditional shelter use are forced to pay increased prices and undertake levels of risk inappropriate for their preferences.
The government ought to recognize that housing speculation is bad for the economy and bad for people in general, and take steps to prevent all the liquidity it must occasionally create in response to economic crises from slopping into unhelpful speculative uses. One possible response might be to end any kind of preferential tax treatment for owning more than one home; another might be to tax capital gains from the sale of existing residential property (other than a primary residence) as ordinary income. The whole point of preferential tax treatment of capital gains is to encourage investment, after all, but I can't for the life of me see why the government would want to encourage "investment" in house flipping.
These measures would not constitute activist government -- they would actually reduce government manipulation of the economy, by removing subsidies of harmful economic activity.