Supply and demand in the housing market

Steve Chapman:

Back in the 17th century in the Netherlands, there was a mass rage for, of all things, tulip bulbs. Prices got bid way up, and speculators jumped in to bid them up higher still. By the peak of the tulip fever, a single bulb was going for the equivalent of thousands of dollars. But eventually the market fizzled and prices plunged.

If I had been one of the people who invested in flowers during the frenzy, I would have felt bad to lose my money. But I like to imagine I would also have taken great comfort in seeing the triumph of rationality -- to find that there was indeed a connection between the real usefulness of tulip bulbs and the price they would fetch.

Actually, I don't have to imagine how I would feel, because I've been a participant in the closest modern equivalent. I'm a homeowner. Not only that, but I bought my current house in 2005, which now looks to have been pretty close to the top of the real estate boom. And I paid more than I really thought it was worth, in the firm expectation that someday, I could sell it at an even more ridiculous premium.

With home prices dropping, that no longer appears to be a plausible forecast. When I sell, I may even take a loss. So I should be weeping. But somehow, I just can't feel that bad. The boom in prices has long been disconnected from the actual utility of a single-family dwelling, and it's satisfying to see reality assert itself for a change.

Back in 2005, you could hardly hear a word about real estate without wondering who repealed the law of gravity. That year, the National Association of Realtors reported that in the previous 12 months, the median price of a home in Phoenix had risen 55 percent. In Orlando, the increase was 45 percent; in the Washington, D.C., area, 26 percent. Nationally, prices climbed nearly 15 percent.

More amazing, this jump was not that far out of line with what had gone before. At the peak last year, home prices in this country were up 134 percent over the previous decade.

They are not rising anymore. According to a report this week, they fell by 4.5 percent in July, the biggest decline since 1991. This will cause some disruption to the economy as a whole, and maybe even a recession. But in truth, the great majority of us will be better off in the long run if the housing bubble has finally burst.

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Demand is down because less credit worthy borrowers have been taken out of the market. This is compounded by homes that were purchased by the less credit worthy borrowers being put on the market adding to the supply and further depressing the price. It will work itself out.

In the mid to late 1980s Houston suffered through a significant drop in demand for housing. The price of oil had dropped to where it was no longer economically reasonable to pay people to look for it in large numbers and some of the companies associated with the oil business failed which had a ripple effect through the economy. Then the Challenger accident set the space program back at NASA leading several companies in the aerospace business to lay off people. I bought a beautiful home near the Space Center during this period where the seller had to bring a check to the table because my purchase price was less than what he owed. Ten years later when I sold the house it was on the market for one week and sold at the asking price which was much more than I had paid. Real Estate is an imperfect market, but it is not immune to the laws of supply and demand.

In some areas of the country the price increases were also attributable to the deliberate restriction in supply by local communities. This is particularly true in California and in major cities on the east coast. This created a situation where buyers had to pay more and were stretched in their ability to afford homes, which may have pushed them into the subprime market. In Texas, where there has been very little restriction on development the prices have remained relatively stable. If my property taxes are any indication, market values have continued to climb.