INTEGRAL ECONOMICS

Unprecedented Fundamentals

Daniel O'Connor | Integral Ventures, LLC

A Federal Reserve analysis of the housing bubble hypothesisignores the Fed's own role in creating the unprecedentedfundamentals on which this entire market trend is based.

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Unprecedented Fundamentals

Daniel O'Connor | Integral Ventures, LLC

With housing prices showing year after year of unprecedented growth across most of the UnitedStates, some have begun to wonder if housingmight be in a bubble similar to the technologystocks bubble of the late 1990s. In response tothese questions, the Federal Reserve has justreleased a new study that addresses this "housingbubble" hypothesis:

"Home prices have been rising stronglysince the mid-1990s, prompting concernsthat a bubble exists in this asset class andthat home prices are vulnerable to acollapse that could harm the U.S.economy."The Fed adopts the definition of “bubble” offered byJoseph Stiglitz:"If the reason the price is high today is onlybecause investors believe that the sellingprice will be high tomorrow—when'fundamental' factors do not seem to justifysuch a price—then a bubble exists."This is a fine definition for a pure market economy,in which any bubbles, manias, or panics can beattributed to the animal spirits of marketparticipants. But we do not live in a pure marketeconomy and the recent trends in home prices aredriven in part by global, multi-state interventions inthe markets for money and credit which have,among other things, created some

unprecedented fundamentals

for the housing market. Whether thisconstitutes a bubble depends upon your definitionof a bubble. However, the above definition side-steps the critical issue of whether the so-called

fundamentals

are themselves the products of unsustainable government policies which, whenthey eventually fail, will create entirely differentfundamentals for this asset class."A close analysis of the U.S. housingmarket in recent years, however, finds littlebasis for such concerns. The marked upturnin home prices is largely attributable tostrong market fundamentals: Home priceshave essentially moved in line withincreases in family income and declines innominal mortgage interest rates."Yes, and home prices have also moved in line withincreases in mortgage debt levels, facilitated by aneasing of credit standards by mortgage lenders andan unsustainable period of low mortgage rates,which is just one manifestation of the

stableinstability

created and maintained by central bankinterventions in the markets for money and credit.

The Fed's own monetary policy and its manymanifestations throughout money, credit, and assetmarkets are the

fundamentals

that explain in largepart why home prices have sky-rocketed in recentyears. But in calling them

fundamentals

and ignor-ing its own role in creating them, the Fed impliesthat they are durable, time-tested, sustainable,economic bedrock. Just don't mention the fault linesand occasional tremors."Moreover, weaker economic conditions areunlikely to trigger a severe drop in homeprices. Historically, aggregate real homeprices have fallen only moderately inperiods of recession and high nominalinterest rates."I would suggest that we’ve never really beenthrough this current scenario, so a profile of pastrecessions is not particularly relevant. The recentalignment of central bank interventions and othereconomic factors that is fueling the growth curve inmortgage debt and housing prices has to myknowledge never before appeared in the US, so itwould make more sense to study the currentconfiguration and develop scenarios for how it maychange in the years ahead. This graph from

TheEconomist

is at least suggestive of the novelty inour current monetary situation:

The recent trends in home pricesare driven in part by global,multi-state interventions in themarkets for money and credit whichhave, among other things, createdsome

unprecedented fundamentals

for the housing market.