The CPI and U.S. Housing Prices

In the early years of the 21st century, as home prices started taking off, I went to the font of real estate knowledge, i.e., http://www.realtor.org/, to seek enlightenment. What I read, or what I remember reading, is that based on historical behavior home prices over time should not increase much faster than the rate of inflation, or else, and brace yourself here, eventually no one could afford to buy a house. This seemed a keep-it-simple-stupid (KISS) explanation of the way things ought to work.

Several years later home prices continued an upward trajectory. No longer were real estate gurus talking about home prices eventually falling back to earth—OK there was some talk about housing coming in for a “soft landing.” More typically anyone with a masters degree in economics and 5 minutes of air time was postulating reasons why the housing boom was likely to continue indefinitely: immigration was fueling demand, people were buying more 2nd homes, Wall Street had devised can’t fail investment products (can you spell collateralized mortgage obligations?) funneling money into mortgages, etc.

There was undoubtedly an element of truth to all this speculation, but it glossed over the cold hard fact that housing prices were increasing faster than people’s income and housing inflation was disproportionately high relative to all the other things measured by the Consumer Price Index (CPI). If you buy the KISS explanation above, something had to give; eventually it did, and we’re still working through the economic fallout.

With the luxury of hindsight I decided to see for myself how home prices behaved relative to the CPI before, during, and after the housing bubble years. Arbitrarily I started my comparison in 1990, using that year’s median U.S. house price as a basis and applying the annual CPI measure of inflation to obtain a CPI-predicted price from 1991 to present. The graph shows actual median house price (blue) and CPI-predicted median house price (red). From 1990 to 2000 actual home prices lagged behind the inflation rate. Starting around 2000 house prices caught up to the CPI and then surged ahead reaching a peak about 2007. Since then, as every real estate agent knows, house prices crashed. Today, for practical purposes, the median house price is back on the CPI-predicted line, suggesting much of the air is out of the housing bubble.

OK this may not be the most sophisticated analysis of the housing market; however, when we rely on pundits to interpret the world for us, a simple model sometimes serves as reality-check, sort of like the little boy who cried the emperor has no clothes.

Notes: As it turns out the CPI is easily found on the web. Surprisingly median U.S. house price are not as readily obtained, at least not if you want 20 years of data. Nevertheless I found several sites that listed historical median house prices. The data was presented as quarterly not annual median price, so I had to do a little massaging. I don’t believe anything I did compromised the validity of the data, at least not for the purposes employed here.