Identifying house price booms and bubbles: A disequilibrium analysis from chaos theory

This research has been motivated by the excesses of public policy since 2008 in an attempt to re-inflate the housing market after the disastrous collapse of housing prices from mid-2006 to their turn-around in January 2012. Is it even possible or desirable to successfully utilize such a vast amount of public resources to inflate a single sector, such as housing, that suffered from such a spectacular bubble and collapse? The consequences suggest that as a way to bolster real household incomes and output, these policies have been a disappointment. In contrast, is there a fear that the monetary stimulus will lead only to serious and unsustainable housing price inflation, if not a bubble? I address these questions in an analysis from the standpoint of determining the stable equilibrium and sustainable house price appreciation rate consistent with the growth of household nominal income. The first problem in identifying stable house price appreciation is to identify the major proximate determinants of household demand for housing. A second is to show empirically the movement, deviation, and variation of these factors over time compared to housing prices. I use median household income as the major demand factor for houses and median single family house prices as an indicator of the price (Federal Reserve Bank of St. Louis FRED database). A third is determining the stable equilibrium of the growth of these factors and the appreciation of housing prices consistent with them. Finally, a fourth is the adjustment process when there are small deviations from equilibrium compared to when deviations are large. It is this last distinction where the theory of self-organizing systems and irreversibility of the housing market system enters to explain how the adjustment process is chaotic in this case. I conclude that, as of the beginning of June 2016, the evidence is overwhelming that housing price appreciation is in a bubble that will likely lead to significant declines in in house prices. An important policy recommendation is for the Fed and monetary policy to begin to normalize interest rates by curtailing the purchases of agency mortgage backed securities and Treasury securities immediately, thus raising rates.