Another bubble?

Good morning, FOCEs ("Friends of the Cranky Economist"). My apologies for the second delayed start in a row. DSL still not working at home. Is a cable broadband connection on the way? We'll see what happens after consultations with the Cranky Roommates.

But although ISPs may come and go, real estate's for ever. Right? The New York Times is apparently thinking maybe that's not the case after all.

So is real estate the new tech stock? Are we in the middle of a bubble?

For starters, let's think about what "bubble" actually means. It doesn't mean just any big run-up in the price of an asset or assets. It means a big, irrational run-up in the price. That is, you only have a bubble when the prices keep going up even though there's no economic rationale for the move. As a theoretical matter, there is some debate among economists about whether "bubbles" even exist. To identify a bubble you have to know what the value should be -- by definition, the bubble price exceeds that rational value. But the dirty secret is that economists have no idea how to determine the "rational value" of just about any asset. Any honest financial economist will tell you, for example, that standard models for calculating the intrinsic value of stocks leave a lot to be desired. So we can't rule out the possibility that what looks like a bubble only appears irrational because our models aren't accounting for all of the reasonable factors that influence asset prices.

So much for the theory. What does this have to do with real estate? Well, there are so many rational reasons that real estate prices should be going up right now that I find it hard to believe we're in a bubble. Herewith just a few I can posit off the top of my head:

• Low interest rates: Mortgage rates have been at phenomenal lows in recent years. But everyone realizes that these lows can't last. Is it so surprising, then, that there would be a big rush to buy while the rates are in the bargain basement? This is a classic price-increasing shift in the demand curve.


• Rising affluence: Lost tech fortunes aside, the fact is that for decades now there has been a continuous upward trend in income and wealth. It is now more possible for more people to contemplate buying a home than ever before. Given that homeownership is something that American culture prizes, of course we're going to start seeing more buyers in the marketplace. And that's not even mentioning the second-home purchases that this affluence allows.


• Migration: As our economy grows less and less agricultural, our society is growing more and more urban. Over time, we've seen a growing exodus off the farm and into the townhouse. One anecdotal piece of evidence comes from my own family, where the value of the Cranky Parents' Cranky Homestead in a medium-sized town (pop. 19,000) situated in a rural area in New England has certainly not benefited from the boom market to the degree that it would were it situated in New York City or Washington. Land may be many things, but portable it isn't. And it's important to note that although in general house prices seem to be rising most places, the rate of increase has been very uneven and seems to depend on the geographic market.


• Those tech-stock scars: Even if a debate still rages about whether the tech boom was or wasn't irrational, it was certainly traumatic to investors who lost their shirts buying pieces of paper that were worth millions one day and nada the next. Couple that with an investing environment where corporate scandals and a sluggish economy (at least until recently) make the stock markets seem less enticing and where low interest rates are holding bond yields down, real estate begins to look like a good place to stick your extra cash.

And these are just the factors that popped into my mind without doing any research on the matter.

Does this mean that prices will continue to rise at the rate they've been going? Not at all. Saying that this is a rational market -- and not a bubble -- does not preclude a fall in the price level. Prices fluctuate in rational marketplaces all the time. But it does mean that we shouldn't assume that just because a market is doing something we only partially understand, it must be acting irrationally.