The 1998-2005 Housing 'Bubble' and the Current 'Correction': What's Different this Time?

Abstract

This paper examines the inflation in housing prices between 1998 and 2005 and investigates whether this run-up in prices can be "explained" by increases in demand fundamentals such as population, income growth and the decline in interest rates over this period. We estimate time series models for each of 59 MSA markets and dynamically forecast price changes from 1998 to 2005 - using actual economic fundamentals to drive the models. In all 59 markets the growth in fundamentals from 1998-2005 forecasts price growth that is far below that which actually occurred. We then examine the magnitude of the 2005 forecast errors in a cross-section. We find the errors are greater in larger MSA, in MSA where 2nd home and speculative buying was prevalent, and in MSA where indicators suggest the sub-prime mortgage market was most active. These latter factors are unique to the recent housing market and hence make it difficult to asses if and how far housing prices will "correct" after 2005.

Keywords: Housing, Bubble