Vulnerabilities to housing bubbles: Evidence from linkages between housing prices and income fundamentals

• DOI: http://doi.org/10.1111/infi.12103
• Published date: 01 March 2017
• Date: 01 March 2017
• Author: MeiChi Huang

DOI 10.1111/infi.12103

ARTICLE

Vulnerabilities to housing bubbles: Evidence from

linkages between housing prices and income

fundamentals

MeiChi Huang

National Taipei University, New Taipei

City, Taiwan

Correspondence

MeiChi Huang, Department of Business

Administration, National Taipei

University, 151, University Rd, San Shia

District, New Taipei City 23741, Taiwan.

Email: meichihuang@mail.ntpu.edu.tw

Abstract

This paper investi gates US state-lev el housing markets by

examining three signs of vulnerabilities to housing bubbles:

negative or in significant co- movements between housing

prices and income fundamentals, high housing-price persis-

tence, and boom–bust regime-switching phenomena. The

study effectively mitigates potential estimation bias by

estimating income growth using three explanatory variables

for housing markets: the stock price, the federal funds rate,

and non-farm-employment growth. The moving-average

thresholds track housing boom–bust regime shifts from a

forward-looking perspective. Although only California

displays high housing-bubble vulnerability in all dimensions

analysed, all selected states show signs of housing-bubble

vulnerabilitie s because income fun damentals lack ex plana-

tory power for housing price dynamics. The results suggest

that the US government had difficulties in stabilizing the

housing market during the period 1976–2010.

1

|

INTRODUCTION

This paper investigates threshold co-movements between housing prices and income fundamentals at

the state level in the United States. During the housing boom–bust cycle of the 2000s, housing prices

departed markedly from economic fundamentals and experienced a sharp decline, although the turning

points differed across local markets. By 2007–08, the collapse in house prices in many state-level

markets triggered a protracted recession and led to a global financial crisis. Given the dramatic

dynamics in the housing sector and the latter’s close links to other sectors of the economy, issues

64

|

© 2017 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/infi International Finance. 2017;20:64–91.

surrounding housing markets have received considerable attention from researchers and policy makers

over the past decade.

As defined by Stiglitz (1990) and docu mented by numerous studies on housing marke ts (e.g.

Case & Shiller, 2003; Himmelbe rg, Mayer, & Sinai, 2005; and McCarth y & Peach, 2004; among

many others), housing bubb les occur when price dynamics cannot be justi fied by economic

fundamentals. Because per sonal disposable income reflect s the affordability of homeowner ship and

the state of the business cycl e, it is widely used as a proxy for e conomic fundamentals in the

literature. Housing price s are expected to be positively as sociated with income dynamics: high

income growth supports upwar d movements in housing prices. Howe ver, housing price dynamics

were not in line with economic a ctivities from 1975 to 2010. We can ob serve this dissociation by

examining the dynamics of hous ing prices and incomes in the two mos t populous states in the

United States: California an d Texas (Figure 1). In general, rea l incomes in the two states remained

on a persistent upward trend durin g this period. By contrast, housing ma rkets displayed sizeable

boom–bust cycles starting with the 2001 recession. Noticeably, California’s housing prices rose

substantially more than the US natio nwide housing-price index, bu t Texas’s housing prices

experienced a relatively sta ble movement. Beginning in mid-2007, California ex perienced an abrupt

decline in housing prices, whi le Texas did not suffer a severe hous ing bust. The two noteworthy

patterns—divergent dynam ics across state-level housin g markets and the disconnect b etween

housing markets and economic fundamentals—demand further investigation.

This paper contributes to the li terature by uncovering dynamic pa tterns to examine the

vulnerabilities of US state -level housing markets to bub bles. Ben S. Bernanke, former Cha irman of

the Board of Governors of the Federal Reser ve, proposed the concept of vulnerabili ty.

1

In his

speech, he emphasized the f ollowing: ‘The distinction between triggers and vuln erabilities is helpful

in that it allows us to better un derstand why the factors that a re often cited as touching off the crisis

seem disproportionate to the magnit ude of the financial and economic reacti on’. Motivated by his

FIGURE 1 Real personal incomes vs. real housing prices at state levels.

Notes: This figure shows the seasonally-adjusted real income levels (left scale, millions of dollars) and real housing

price indexes (right scale) for California (CA), Texas (TX), as well as the nationwide real housing price (US) for the

US. The shaded areas represent the NBER-dated recessions in the US. The housing prices come from Freddie Mac

House Price Indexes, and the state-level incomes come from the Regional Economic Accounts of the Bureau of

Economic Analysis (BEA). Prices and incomes are deflated by the core CPI (Consumer Price Index for All Urban

Consumers: All Items Less Food & Energy), sourced from the US Department of Labor, Bureau of Labor Statistics

HUANG

|

65