Can This Possibly Be True?

Via Matthew Yglesias, it seems that Casey Mulligan is not sure there was even a housing bubble. As part of her argument, however, she says something that sounds very wrong:

Now that the bubble is behind us, people today should be no more willing to pay to own a house than they were in the late 1990s. (It’s true that population has grown since the 1990s, but population growth is nothing new and should not by itself increase real housing prices. Don’t forget that greater population also means more people available to do construction work.)

The cost to build a house is essentially land, materials, and labour. Increasing population means less land per person, so (all else being equal) the price of land will increase. I imagine that over the last decade the price of raw materials has increased. Even if the labour costs are constant (and in Vancouver, at least, they have soared), the price of the house should still increase.

On this shaky foundation, Mulligan builds a very unconvincing argument. She shows the following inflation-adjusted housing price graph, normalized so that 1994-1997 is 100:

She argues that, according to bubble theorists, there was a 3-4% "over-build" of houses during the bubble, so there must be a 3-4% drop in prices from the pre-bubble level. This estimate is shown in the blue line. She concludes:

But another interpretation is that a large fraction of the housing price boom was justified by fundamentals (and next week I’ll consider some of the specific fundamentals that may have permanently increased housing demand in the 2000s). If so, we are probably asking too much of the Federal Reserve and other regulators to accurately disentangle bubbles from fundamentals the next time that asset prices rise.

So what sort of a "large fraction" are we talking about? In February, 2000, the index was around 105. Today, it's around 111. Assuming that Mulligan is right and that housing is now properly priced, this 6 points of growth can be attributed to fundamentals. However, at the peak in 2006-7, the index reached 130. Assuming 6 points of this was fundamentals, that still leaves 19 points of bubble. The "large fraction" is therefore 6/25, or 24%.

Please note that this is assuming everything that Mulligan says is true. I would argue that it is not. Mulligan does not even mention the role of the $8,000 home buying tax credit in boosting demand for housing. In the Northeast, the most expensive housing market in the US, the median selling price last month was $249,800. The home buying tax credit represents 3.2% of the cost of buying the house. Neglecting this from your analysis is negligent.