The strong housing data is taken as proof that the economy has turned around and that a recovery is under way. Cooler heads may simply see how government policies have channeled money into real estate in order to reflate a bubble that has been collapsing for the last five years. Although the money is entering the market through slightly different paths than it did in 2005 and 2006, its effects on housing, and the broader economy, are the same as they were before the bubble burst. When the inevitable happens again, the ensuing damage will be eerily familiar.
After five years of dismal real estate performance and a lackluster economy, it’s hard to fault people for believing that rising home prices are a good barometer of economic health. There can be little doubt that rising home prices feel good. Even single digit appreciation can make modest home buyers feel like mini-moguls. The effect is magnified in a falling interest rate environment where any appreciation can be instantly turned into an opportunity for cash out refinancing. The “wealth effect” created by such activities then translates into consumer spending and other seemingly positive economic developments. But some things can taste great but be very harmful (cinnamon buns come to mind). It felt good when real estate prices were rising during the pre-financial crisis bubble, but that rise only exacerbated the problems when the bubble burst. The questions we should now be asking ourselves is why are prices rising, are those higher prices sustainable, and what are the costs to the broader economy?