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Identifying Housing Bubbles

Housing BubbleOn Thursday Freddie Mac published an Insight blog post that details the three signs to identifying a housing bubble, and evaluates current market conditions against them.

According to Freddie, the first warning sign is prices skyrocketing until they reach unsustainable levels. If that happens, home prices can either burst or the market can fix itself through natural means. If the latter happens, it’s automatically not a bubble as Freddie Mac counts home prices bursting as the second sign. “In our view, if it doesn’t burst, it wasn’t a bubble,” said the report.

The third sign of a bubble is the presence of easy credit, which ties back to the first step, as credit leads to buying, which leads to more demand and raising prices.

Now that we know the signs, the big question is if they are presenting themselves in the current market.

Freddie Mac reports that house prices today currently are rising, though not quite at the same level as they did during the mid-2000s. It’s still worth mentioning that the house-price-to-income (PTI) ratio in large metropolitan statistical areas in 2011 was 5 and it’s 17 now. On average, there the housing supply is at  3.3 months, but that ranges from over five months in New Orleans to less than a month’s in San Jose, California. There’s inconsistency in demand across the nation, which means that a bubble is not on the horizon.

However, while house prices today certainly are increasing, the report found that the high prices are unlikely to collapse. In part, what will keep the prices from bursting, is the ongoing lack of housing inventory. Freddie Mac found that there has still been a lack of construction permits relative to the population, which will keep this demand afloat.

Freddie Mac also states that the last indicator of a bubble, easy credit, is not present because it is more difficult than ever to qualify for a mortgage today, and homeowners are not increasing their mortgage level.

So, is a bubble on the horizon? “The short answer is ‘not yet.’ But the concern is understandable. The scars are still fresh from the collapse of last decade’s house price bubble. And warning signs of a possible new bubble are accumulating,” said Freddie Mac’s Chief Economist Sean Becketti.

To read the full analysis, click here.

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