An instrument designed to warn of impending housing bubbles is flashing warning signs.
Economists at the Federal Reserve Bank of Dallas created an “exuberance indicator” that examines home price data and detects periods when home values are inflated relative to market fundamentals like demand, household wealth, and economic growth. As the chart below shows, the market has been exuberant for at least five quarters.
It’s no secret that prices for homes have been soaring—in the year through September, they were up 19.5%, according to the latest data from the S&P CoreLogic Case-Shiller Home Price Index. But whether houses really are that valuable is a matter of debate.
The exuberance indicator, which uses sophisticated programs developed by Yale economist Peter C. B. Phillips and others, is designed to spot “explosive behavior” in markets. If the indicator is above a certain mathematically determined value, that means the market is exuberant, and could be headed for a crash.
In the past, periods of exuberance in the housing market have been followed by corrections, including the one that precipitated the 2008-2009 financial crisis.
But many economists have said the rising prices are justified based on the fundamentals—houses are in high demand because of the pandemic’s work-from-home trends, and there are few of them on the market. That’s nothing like the 2000s, when the boom in housing prices was built on a flimsy foundation of bad credit, or so the argument goes.
While the math behind the exuberance meter is complicated, the conclusion is not—the U.S. is “clearly showing signs of exuberance,” a Dallas Fed economist said in an email. (The Fed economists couldn’t elaborate much, since they’re under a “blackout period” in advance of this week’s upcoming Federal Open Market Committee meeting.)
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