William White, chief economist for the Bank for International Settlements, warned about the problems in 2003, but his call for action went unheeded.

“For years, the regulators of the global money supply ignored the advice of their top experts, probably because it would require them to do something unheard of, namely embark on a fundamental change in direction.

“The prevailing model was banal: no inflation, no problem. But White wanted central bankers to take things a step further by preventing the development of bubbles and taking corrective action. He believed that interest rates ought to be raised in good times, even when there is no risk of inflation. This, he argued, counteracts bubbles and makes it possible to lower interest rates in bad times. He also advised the banks to beef up their reserves during a recovery so that they would be in a position to lend money in a downturn.”

In a 2003 paper, presented at a symposium at Jackson Hole, “White and Borio described the dramatic changes that had taken place since deregulation of the financial markets in the 1980s. Price stability was no longer the problem, they argued, but rather the development of imbalances in the financial markets, which were increasingly causing earthquake-like tremors. . . .

“All it takes to predict such imbalances, White argued, is to monitor “excessive credit expansion and asset price increases,” and to take corrective action early on, even without a pending threat of inflation.”

As others here have opined, White says that the keys are credit expansion and price increases. :)

If you instead look at peoples behaviors, you have a much better chance. When people start discarding rules normally used as yardsticks to assess risk, something has failed. The bloggers at calculatedrisk did this, and clearly were out in front on the issue of the housing bubble.

DWN

That may be true in individual markets, but in aggregate there is only so much money to go around. Society as a whole, and even individual households, cannot commit more of a percentage of their after tax income to housing unless either:

* Other goods become cheaper
* People forego other consumption in favor of housing (which must always be viewed with skepticism, given the predillection of humans to manias.)
* People use debt to forward shift future income

Those are your options. Have other goods become cheaper? Perhaps, but it doesn’t seem so in aggregate. Are people willing to forego consumption in order to pay more for housing? Not in the last decade they haven’t. So what changed? Easy debt.

Long run, income must support the total debt load and, worse, when the debt load is based on fundamentally non-productive assets, such as housing, you have to pay the interest out of other productivity improvements.

There can be some small, concentrated markets that show no relationship to income, of course. But entire MSAs must largely have income in line with housing over the long run, unless they become entirely dependent on income from other areas.

James, I disagree with your premise that housing should be analyzed on a per-house basis. At the end of the day, it is income that must support housing prices, not “what someone is willing to pay.” We’ve just seen a decade of people willing to pay about double what was an actually supportable price level, built entirely on debt. And now we are seeing the, to me anyway, obvious ramifications.

In short, I continue to believe that housing bubbles are both obvious and preventable.

Cheers,
Carson

When the securities firms and rating agencies originally issued the fraudulent derivatives, they had to know they could be sued. And now they are and I hope they pay through the nose. That is how the system is supposed to work. Fraud is to be punished. When it is not, fraud flourishes.

Until those firms, who believe they have special privileges are forced to play by the same rules as everyone else, the market will not return to normal functioning.

Also, while I’m no friend of the ratings agencies, I have little sympathy for Calpers here. They supposedly had sophisticated finance people managing their investments, and paid Wall Street size compensation by the taxpayers to do so. Their complaint essentially says that they bought a pig in a poke because the seller’s friend, whom they well knew was paid by the seller, said it was a good deal. Give me a break! I can see grandma getting suckered into that deal, but these are supposedly professionals. The pensioners should be suing Calpers.

An asset price which has gone up for more than a year and far more than anyone expected, is a candidate for a bubble.

If “reflexive” factors upwardly reinforce each other contribute to the higher asset prices are discernable, the probablity that the asset is in a bubble rises.

Finally, if OTM put options (10 delta or lower) trade at far higher implied volatilities than ATM options on the underlying (potential bubble) asset, then some market practioners have spotted it, and the probability of a bubble is, thus, higher.

Expectations, surveys, trading volumes, long term historical similarites, media coverage, and related manias, could also be deployed to estimate liklihood of a bubble.

But the nature of major bubbles almost necessitates that all of society gets caught up with believing it.

Negative bubbles need to be considered as well.

Nick in Kyoto

But as Dave correctly points out, this will make great courtroom theatre. The discovery process alone will be worthwhile.

If you were never able to monetize the value of your next home, what would you be comfortable paying? That’s a better measure of affordability and maximum prices than asking how much you’d be prepared to pay now if you expected to sell it for 50% more 10 years from now. With that kind of gain, and the typical leveraging allowed now, buying a home is like being given free housing.

How can you assess what prices would be if people didn’t rely on getting all their own money back with significant gains? I suggest a simple way is to require minimum downpayments of 30% of the price, going down to 20% for buyers that can prove all the money is theirs, and the price is true market value, and it’s owner-occupied etc. It’s not perfect, but if people had to put up a lot of their own money up front, then they would be less cavalier about paying well beyond the underlying “fundamental value”. And if you can’t fund 30% of your home’s price in your 30’s and later, or maybe 20% in your late 20’s, then you probably cannot afford the home.

In fact, why do we subsidize, through the home mortgage interest deduction, loans of more than 2 x (65 – Age of owner)% of the value of the home? If we made interest on the excess over that non-deductible, that would really help make home prices less bubble-prone, and encourage people to save for retirement.

The problem is information. People who looked at the construction boom did not know what the banks were doing, what assets they were buying, how much financial crap was being created. As Rumsfeld said: there are things that you don’t know that you don’t know. The dots weren’t connected.

If you overpay for a house hoping to sell it to a greater fool at an even more inflated price, is that not the very definition of a bubble?

Key word urban consumers. Most housing bubbles started in rural areas that became urban. Example: a farmer/rancher sells his land for development. It isn’t until the population reaches a certain level that it even gets noticed.