RSF Briefing on House Prices

THE role of house prices in the economy is still contested by policy-makers. No such disagreement exists among home-owners, however. Rising prices encourage the feel-good factor. We borrow against increases in the equity of our properties and spend the money in the shops. But for buyers, price rises are a menace – they take increasing proportions of disposable incomes. And for some first-time buyers, there comes a point where prices of the cheapest homes rise beyond the levels of affordability. So a consistently rising trend poses a threat to those who wish to start families within the security of their own homes. In the US, in 2005, house prices rose at annual rates of about 14 % a year (see graph), achieving a level of 16.6 % in October compared with the same month in 2004. Is this good or bad news? For market analysts who track the performance of real estate, the prospect of a slow-down in prices is alarming. But what does such a slow-down signal? For outgoing Federal Reserve chairman Alan Greenspan, house prices were a challenge because, he claimed, it is not possible to identify a bubble until after the event. But what follows if a price boom is driven by speculative behaviour? Does a slow-down always result in a recession? Or can a bubble be followed by a “soft landing”? Greenspan’s successor, Ben Bernanke, is relaxed about weakening house prices. He remarked in October 2005: “House prices are unlikely to continue rising at current rates…a moderate cooling of the housing market, should one occur, would not be inconsistent with the economy continuing to grow at or near its potential next year”. US house prices have been stimulated by cheap foreign financing which made it possible to keep interest rates at low levels – and, in the process