Should you buy a house?, Megan McArdle asks:
For most of history, a house was simply a very long-term durable good, which, like cars and refrigerators, began depreciating the day it was finished. Why do we think differently now?Shiller’s argument, which I find pretty compelling, is that we’ve been deluded by recent history. Since World War II, a number of developments have conspired to boost the prices of homes, giving a large capital gain to those who were lucky enough to own at the time. This has given us the delusion that house prices rise steadily, when in fact, we have virtually certainly exhausted the pricing gains of those happy developments.
The first boost was the invention of the long-term amortizing mortgage. Mortgages used to be short-term loans of perhaps five years, with a whacking great balloon payment due at the end. This started to change in the 1930′s, when the government housing administration, trying to preserve homeownership during the Depression, invented the 20-year amortizing loan. That trend really took off in the 1950′s, with the invention of the 30-year loan.
People tend to base what they will pay for a house on how big a monthly payment they can afford. Since everyone started getting 30-year loans roughly at once, without a concomitant boost in the supply of housing, the effect was to raise the prices that current homeowners could charge for their properties. This trend is largely played out, however. Though there was a wan attempt at introducing 40-year mortgages at the height of the bubble, the loans were not particularly popular with either lenders or borrowers. It’s conceivable that a couple in their late twenties or early thirties is buying a 30-year house, but a 40 year house stretches the imagination too far, and the income expectations into the social security years.
The second trend is the progressive income tax, which really got going seriously in the 1940′s. This gave another boost to homeowners, by making it possible for buyers to afford much bigger payments. While this may fluctuate somewhat over the next few years, tax rates seem to be fluctuating within a fairly narrow band, which means that this upward pressure on house prices will also be limited.
The third trend is the changes in inflation and interest rates since World War II. Prior to the 1960′s, inflation tended to be fairly stable, meaning that the true cost of your mortgage was fairly predictable. Then inflation started to take off, making existing mortgages very cheap, and new mortgages very expensive. But starting in 1980, the Federal Reserve got tough on inflation. As the Fed’s credibility as an inflation fighter grew, lenders stopped demanding such large premia for long-term lending, meaning that the real interest rates on mortgages fell. Since, as discussed above, potential buyers were more worried about payments than prices, that has given a big boost to house prices over the last quarter-century. But that trend, too, is played out. Inflation is set about where it’s like to be for the foreseeable future, fluctuating right around 2%. Both mortgage lenders and buyers are calculating the interest rate they will pay on those low inflationary expectations; hence, no future bonus.