Tuesday, September 7, 2010

Looking back for signs of trouble

by François Ortalo-Magné, Department Chair, Professor and Robert E. Wangard Chair of Real Estate

Now that the housing boom is over, it is incumbent upon us to look back for signs of trouble to which the market could (and should) have paid attention before it all got too crazy. Monika Piazzesi and Martin Schneider, both at Stanford University, propose evidence from the Michigan Survey of Consumers. The survey asks “Generally speaking, do you think now is a good time or a bad time to buy a house?” A follow-up question asks households the rationale behind their answer. These figures are reproduced (with permission) from their paper.

Allow me to point out the following key features:
  • The proportion of households who thought it was a good time to buy peaked way before the end of the boom (2003Q2). The proportion at the peak was not higher than in previous booms.
  • The main rationale for the good time to buy was “credit is cheap” but again with a peak in mid 2003 at a level similar to peak levels in past boom.
  • What was new this time? From 2003Q2 onward, the popularity of the good time to buy answer started declining but not as fast as in past cycles because of a very unusual increase in households feeling that housing prices would continue to go up, that housing was a good investment.
Piazzesi and Schneider go on to make the point that the proportion of such optimists (called momentum traders) does not need to be high to drive prices to an unsustainably high level.

Lessons for the future should be obvious!

Reference: Piazzesi, Monika, and Martin Schneider, “Momentum Traders in the Housing Market: Survey Evidence and a Search Model,” American Economics Review: Papers & Proceedings, 2009, 99:2, 406-411

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