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Are falling house prices good or bad?

House prices have been falling quickly in both the US and, more recently, the UK. Newspaper reports tend to use negative language to refer to this fall. For example, todays edition of The Independent says:

Today’s gloomy data, which is worse than economists had forecast, …

However, it is not at all obvious that low house prices are a bad thing.

If the price of oil or food began to fall back to their old levels, newspapers wouldn’t report that this was ‘gloomy’. Instead, most people would be happy that things they buy had become cheaper. Houses are currently getting cheaper. Isn’t that a good thing? It certainly is for those who don’t own a house yet, and these people are typically poorer than home owners. Even people who will always rent and never buy a house should count the declines as good news, for if houses cost less then rents will be somewhat lower too.

What about for those people who already own a house? This is the difference between property and food or oil: many of us own a home, but don’t own masses of food or oil. For home owners who are likely to trade up to a more expensive house in the future, then it seems to be good news for them too. Suppose you were going to move from a $200,000 house to a $250,000 house in a better location. The trade would cost you $50,000. For simplicity, suppose that prices halve. Then the new trade will only cost you $25,000 for the same exchange. The real losses of cheaper houses are felt by those who are trading down, or those who are leaving the market entirely. For example, a pensioner moving to a cheaper dwelling, or the executors of a will disposing of the deceased’s property.

The winners and losers from low house prices are from a mix of income groups, but in general, it seems that poorer people gain from low house prices at the expense of richer people due to the simple fact that those owning houses tend to be richer. Falling house prices would seem to be (in general terms) a transfer of wealth from the rich to the poor, which we know can be beneficial overall, especially as in this case no total wealth is lost when the house prices go up or down. Rising house prices lock out the poor and lead to a transfer of wealth from the poor to the rich.

Of course, there is a key group that I haven’t yet mentioned: those who bought their first houses at the peak. For them the decline is a very bad thing. Many of them bought at record high-prices, scared that if they didn’t jump then, they would be forever off the property ladder. However, as this explanation shows, they can be seen as victims of high house prices just as much as victims of low house prices. What really caused their misfortune is house price variability: uniform low prices would be ideal. In spite of the media’s heavy slant, it is quite possible that things are still better overall with the falling house prices than they would have been were the prices to have stayed at their record highs.

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3 Comment on this post

  1. But with people being foreclosed on, rental demands are on the rise, and so rents are actually increasing, not decreasing. It would be one thing if housing prices were on the decline and the economy wasn’t being dragged down with it, but because it is, its not entirely a benefit for the poor who are looking to get into a house. Rather, its a benefit for the rich who are able to “invest” into real estate. Its a case of the rich getting richer.

  2. That is a good point about the foreclosures increasing rental demands, though that effect should go away with time: it is a product of the rapid drop, rather than the new lower level. In general, higher rents need to be charged when house prices are higher in order for the house to remain a profitable investment. In addition, high house prices also lead to more relative demand for rental accommodation, which leads to rents going up (though not necessarily by the same amount). Thus, lower house prices should end up producing lower rents, even if the short term situation goes the other way.

    The point about the effect on the economy is also interesting. Changes in house prices at the moment are not due to housing becoming less valuable to us in an absolute sense (our houses haven’t got worse). Instead, it was all a paper gain and is now a paper loss. The paper gain during the bubble might have stimulated the economy, I imagine most economists would not recommend keeping things artificially inflated rather than allowing them to return to their true values.

    All that said, I am not an economist and would defer to them on any of the points of prediction in my post. I was just pointing out that despite the general perception, lower house prices can potentially be a good thing, especially for the poor, and when considered over the long run. The media’s angle seems to be based more on their median reader than on the breadth of effects.

  3. It’s important to distinguish between the falling of home prices, and low prices for homes.

    Yes, low prices would other things equal be an indication that the real cost of housing is low. More capital would thus be available for the satisfaction of other interests. Other things equal, yes, that is good.

    A falling price is something else. In particular, when prices fall dramatically, quickly, and on items of such high absolute price as homes, this can be both an indication of and a cause of bad effects overall.

    The dramatically falling price is an indication of a massive misallocation of capital. So, it is not just the investors who overpaid for housing (as owners, or as producers) who are harmed. Opportunities for more efficient uses of capital, and hence for jobs and the creation of real wealth throughout other sectors of the economy, were lost. So, even given that some people benefited from the bad investments, the investment pattern prior to the price adjustment was significantly worse overall than it could have been.

    The abrupt transition from higher prices to lower itself can create bad effects, too. The mechanisms by which price and value become more accurately aligned very quickly, and on a large scale– bankruptcies of large institutions, massive layoffs, fire sales, and acute short-term shortages of capital– tend to have large transaction costs. Other things equal, prices falling more slowly permit less violent methods of adjustment.

    The present problems in the United States have to do with what rapid and large price falls indicate and cause, not the good of low-priced homes.

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