Monday, June 27, 2005

How to think about a housing bubble 

Bryan Caplan is thinking about housing bubbles. The problem most economists have with bubbles is that in a market that functions well, arbitrage opportunities should cure bubbles. But, Caplan says,
What would I actually do if I knew for sure that my house was going to plummet in value one year from today? My ideal solution would be to sell my house to someone, rent it from them for a year, then buy it back. But that would be very hard to arrange. In practice, I'd have to sell, rent whatever's available for a year, then use my nest egg to buy a comparable (or better home), pocketing the difference.

There's a lot of transactions costs built in there. For starters, there's moving costs x2, plus all the pain and suffering of changing my address and phone number twice, plus the loss of sentimental value in my current house. And don't forget opportunity costs - I'd say that 100 hours each for me and my wife is a conservative estimate.

So how much money would I have to net to make me sell, rent, and buy again after the crash? Frankly, it would take $200,000 just to pique my interest. And that's with certainty. Maybe I'm unusually averse to moving, but I can easily see people with kids in school being even less mobile than I am.
And if the difference is really that large, that creates a big hole in "no $20 bills on the ground in the housing market" story.