In what I'm sure the author thinks passes for enlightened, even nuanced, thinking, Paul Krugman of the New York Times writes there is indeed a home pricing bubble and America is in for "a nasty correction."   The trouble is Krugman's analysis is not nearly nuanced nor enlightened enough.

Krugman attempts to educate not only the Times' and Moody's real estate journalists, but also you poor slobs who believe their report indicating that housing prices have never been more affordable.   He does so by enlightening us with his mastery of the history of housing prices and historical economic conditions but misses quite a few facts which cause his entire analysis to fall on its butt.

To begin with, housing is one of the purest markets available for study.   Yes the government gets involved but even with that involvement, the market itself is so big and the forces of independent decision making so dominant, that the effect of government intervention does not alter many of the most important dynamics which determine pricing.   In its most rudimentary terms, home prices are determined by the free will of a large number of buyers negotiating terms with a large number of sellers.

If we examine the dynamics behind home prices in a microcosm, think of a town with 2,000 families.   There are 1,000 homes available for purchase and 1,000 rental units.   1,100 families are in a financial position to purchase homes.   These 1,100 families will freely compete to buy the available 1,000 homes by analyzing what they can pay each month in mortgage payments and other costs associated with home ownership.   Then they will bid in an open market to acquire the available stock.   Because there are more buyers than stock, prices will be higher as the last 200 buyers compete for the final 100 homes.   Some will fail in their efforts, settle for renting and then save additional sums to one day eventually bid up against the market or purchase newly constructed units.   If there are 1,200 "ownership" homes in our example, all who seek home ownership will achieve it and then some renters will be encouraged to buy instead of rent because prices are more reasonable.   The rate of interest, because it is a significant part of the equation for determining the total cost of home ownership, will, of course, have a significant influence on how many people can afford to buy and, therefore, the prices at which homes change hands.   This is a simple analysis but the bottom line is housing prices are determined based on available stock, income and savings of available buyers, and costs associated with home ownership including mortgage interest rates.

Krugman says before we analyze housing prices, we must first divide the country into two segments, "Flatland and the Zoned Zone," Flatland being what the liberals like to call "flyover country" and Zone being the big, sophisticated cities where all the smart people live.   He says "In Flatland, there's plenty of room to build houses, so house prices mainly reflect the cost of construction.   As a result, Flatland is pretty much immune to housing bubbles."   But "In the Zoned Zone, by contrast, buildable lots are scarce, and house prices mainly reflect the price of these lots rather than the cost of construction.   As a result, house prices in the Zoned Zone are much less tied down by economic fundamentals than prices in Flatland."   I hate to have to explain this but the scarcity of buildable lots in the "Zone" is an "economic fundamental" which has as much to do with the available housing stock as anything else.   All Krugman has accomplished by pointing this out is to inform us of what everyne already knows, there is more land on which to build in places where there is more land.   No, duh!   This does nothing to change the home buying calculus.   It simply says the weighting of factors of available stock, available qualified buyers and home ownership costs are different in different areas.   Krugman's analysis fails because the premise on which it is based is false but let's take a look at the rest of what he says.

Krugman educates us about the recent economic history of this country - the history while he has been an adult - especially as that relates to housing prices.   He says, "the unaffordability of housing in the early 1980's led to an epic collapse in the housing industry.   Housing starts fell from more than 2 million in 1978 to only 1.06 million in 1982.   And the housing implosion was one of the main factors in the worst economic slump since the Great Depression, which brought the unemployment rate to a peak of 10.8 percent at the end of 1982."   This is an incomplete story telling which causes incorrect conclusions.   Let's look a little deeper into the macro-economic equation and economic history of the 1980s.

This country, under Jimmy Carter, suffered one of its most unstable economic periods in history.   Interest rates were absolutely insane and this stifled investment (including home building) because while interest rates were extremely high, nobody could say for sure that they wouldn't go higher.   Inflation came along for the ride.   Businesses were busy servicing their exhorbitantly expensive debt and closing up factories in order to free cash flow for debt service.   Fewer goods were available.   The economy contracted with almost unprecedented speed.   Unemployment resulted and that caused the economy to spiral even further downwards as nobody could afford to buy the ever-more expensive scarcer goods, including housing.   Builders didn't build homes because they weren't sure they would be able to cover costs of construction, including a good helping of exorbitant and rising interest.

Into this economy of partially clogged arteries, the country injected the adrenaline of Ronald Reagan who took the drastic step of creating huge tax incentives for business investment in the tax act of 1981.   This act allowed businesses to deduct the cost of capital outlays at a much quicker rate via a depreciation scheme called ACRS.   Not only could they depreciate property in an accelerated fashion, they were also able to take advantage of dollar for dollar tax offsets called investment tax credits.   The result of this tax legislation was an unprecedented recovery from an unprecedented slump.   Businesses couldn't channel money fast enough into new factories and other capital goods.   The country went back to work, businesses invested huge sums, the engine was put back into service.   And somewhere along this process it finally occurred to all the newly employed people that they wanted to own homes but because builders hadn't built any in quite some time, there were far more buyers than sellers.   After this began to cause real estate prices to rise rapidly, investors who had more money than they new what to do with began to invest, even speculate, in real estate.   This caused prices to rise dramatically in unsustainable ways.

When real estate prices got about as high as they could go, along came another tax act which took away most of the huge tax advantages real estate investors had benefitted from.   The tax code change was referred to as the "passive activities loss limitations" and it changed the entire real estate speculation dynamic in this country in one fell swoop.   I know this because in the late 80s I was a young tax accountant who was busy running spreadsheets for real estate investment partnerships.   Before the tax act, a $1,000 investment would yield a bunch of rich guys, including the likes of Lee Iacocca, a $2,000 annual cash flow.   After the tax act went into effect, all these rich guys not only had no impetus for new investments, they had to get out from under their existing ones.   The result was a real estate glut like none this country has ever seen.   Prices dropped, then stagnated for more than a decade.   I bought my first home in the middle of the stagnation.   The seller was almost moved to tears as he told me how he had paid far more for the property than he was about to sell it to me for.   I then sold it at about what I bought it for and purchased a bigger home right at the beginning of the new housing price boom.

The economic history of this country tells us that housing is always in short supply.   Prior to the run up in prices due to the booming economy of the 1980s, followed by the passive activity loss limitations, this country had never seen a drastic home price correction in any real, appreciable way.   I remember one of my roomates telling me he was buying a house not only because he had saved enough money but also because house prices have never fallen in history so it was a safe bet.   He was right and wrong.   History tells us that home prices always rise in real terms.   But this is always "in the long run."   John Maynard Keynes tells us "in the long run we are all dead" but that doesn;t really change the fact that over longer periods, real estate always rises because they ain't makin' anymore land.   There are certain to be bumps along the way but short of a real disaster economically or otherwise, the forces which caused the singular event of the late 1980s to the late 1990s just do not exist today.

Krugman concludes his analysis by claiming that interest rates are "already low by historical standards" so we are in for a "nasty correction."   Truth be told, interest rates are not low by historical standards.   When I studied economics in college, I learned that the real rate of interest is somewhere between 2% and 4%, probably closer to the 2.   When you add the real interest rate to the rate of inflation, you get the rate you see in lending advertisements.   Our current inflation rate is around 3% - 4%.   Adding the two together, yields an expected actual interest rate of somewhere between 5% and 8%.   It seems to me that's right around where mortgage rates are today.   This analysis is far too simplistic and inaccurate but it does show that our current interest rates are perfectly in line with historical ones.   And all indications are that the Federal Reserve is likely to either not bump rates up or not bump them up significantly because the economy should cool and inflation seems to be tamed.   There is no reasonable basis on which to claim that interest rates are headed for a huge increase causing housing to come crashing down.

There may be a housing bubble in this country but it is peculiarly local in the sense that only certain markets are at real risk of a stagnation or fall.   We may see some overall stagnation or flattening out of prices where they have rapidly increased but that's to be expected in any market.   It is just as easy to argue that the current run up of prices results from a correction to those at the end of more than ten years of drops followed by stagnation.   New York Times journalists get upset by the price of homes in the limited areas they typically live like Upper Montclair, New Jersey where there is no additional land on which to build.   But last time I checked, they still were not making any new land even in New York City.