IN PRINT: A Look at U.S. House Price Bubbles from 1980-2010 and the Role of Local Market Conditions July 2011

A Look at U.S. House Price Bubbles from 1980-2010 and the
Role of Local Market Conditions

By James R. Follain and Seth H. Giertz

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ABSTRACT: This article, sponsored and published by the Lincoln Institute of Land Policy, looks at data from house price bubble-and-bust scenarios over the last 30 years in an attempt to gain insight into forecasting and managing future bubbles.

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James R. Follain is a senior fellow at the Rockefeller Institute, with extensive experience in the empirical analysis of housing and mortgage markets, and the public policies that affect them. Seth H. Giertz is assistant professor of economics in the College of Business Administration at the University of Nebraska-Lincoln. Their full article is published by the Lincoln Institute of Land Policy.
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The authors investigated the relationship between housing prices and several explanatory variables such as employment, income per capita and interest rates for a large panel of U.S. metropolitan statistical areas (MSAs) to determine the potential for predicting the likelihood of future price bubbles and busts.

Their findings suggest that projections of housing price appreciation and depreciation improve when local market conditions are given significant weight. This was especially true when forecasting so-called “extreme events,” such as the housing bust that began in many parts of the country in 2007. The authors’ projections for 2008-2010, using local market data through 2007 and prior to the bust, proved to be highly correlated with actual house price changes in 2008-2010. That is, their model accurately predicted which of the MSAs would suffer the largest price declines in 2008-2010; however, model projections understated the magnitudes of the housing price declines that occurred.

The model estimates also strongly confirm the importance of the gap between the level of prices in a particular year and MSA, and those predicted by the fundamentals and MSA specific indicators or fixed effects. That is, house prices were found to fall most precipitously in 2008-2010 in those MSAs in which the prices were most “out of whack” with the levels suggested by the fundamentals and the fixed effects.

Another key part of the authors’ approach was the attempt to incorporate home buyer expectations of future price appreciation, an important source of the demand for housing. These expectations are captured by measuring the role of “momentum” in house prices: the tendency for house price appreciation in one year to be followed by similar growth in the following year. Momentum tends to build and fuel house price growth until circumstances or events prompt prices to begin falling. At that point, the momentum works in the opposite direction.

The model estimates also confirm in several ways the importance of momentum and local market expectations of future house price appreciation. More generally, the model estimates confirm the importance of what the authors label “local market conditions,” which include the three-year histories of the growth rates in real house prices, employment, real income per capita and a variety of estimated or fixed effects unique to each of the MSAs in the study.

More broadly, the analysis underscores the complexity of forecasting bubbles. It especially highlights the difficulties of doing so based upon the notion of a national housing market. Even in recent years, housing markets are heavily influenced by local supply and demand. The authors recommend adjusting federal policy to local market conditions, as one-size-fits-all solutions do not work.


The Nelson A. Rockefeller Institute of Government, the public policy research arm of the State University of New York, conducts fiscal and programmatic research on American state and local governments. It works closely with federal, state, and local government agencies nationally and in New York, and draws on the State University’s rich intellectual resources and on networks of public policy academic experts throughout the country.