THIS was a week for worrying about housing bubbles. Alan Greenspan, chairman of the Federal Reserve, may have dismissed the idea of a bubble in the United States; but he believes that the house-price boom will slow this year. The IMF said Britain's house prices may be over-inflated, and the OECD fretted about the Australian market (see article). If any of these potential bubbles burst, consumer spending would suffer too.


Australia, Britain, Ireland and Spain all saw double-digit increases in house prices in 2002. House-price inflation rose in eight of the 13 countries covered in the year to the fourth quarter, but fell in five (see table 1). Prices fell in Germany and Japan, which have yet to recover from the bursting of property bubbles in the 1990s. In both countries prices are lower than in 1995.


Against these price rises, America's house-price boom looks modest. Even so, in real terms the average price gain over the past few years has been the fastest in history. Moreover, national figures conceal local bubbles. Parts of California and New York have seen house-price increases of more than 80% in the past five years.

Mr Greenspan acknowledges that there are local hot-spots, but rejects the notion of a national housing bubble, arguing that high transaction costs discourage the buying and selling frenzy seen in financial-market bubbles. (That hasn't prevented housing bubbles elsewhere.) He also sees little sign of an over-supply of new homes, which could later cause prices to plummet.





In Britain and Australia, house prices look more out of line. In Sydney and London, prices would have to fall by at least one-third to bring p/e ratios back to their long-term averages immediately. Rising rents could ease the price adjustment, but in both cities rents are falling. Some London landlords have had to reduce rents by 20% in the past year to find new tenants.

This time is different

Nevertheless, housing-market analysts insist that prices will not crash. Lower interest rates, they argue, justify a higher p/e ratio for housing. But future rental income should be discounted using real interest rates—not nominal rates, which are low only because inflation is too. Japan and Germany have learnt painfully that low nominal interest rates are no protection against house-price declines.

Indeed, if homes become seriously overvalued, then low inflation makes a fall in house prices more, not less likely. When inflation was higher, real house prices could fall even if nominal prices did not. Today, with inflation near zero, nominal prices would have to fall.

Granted, nominal house prices have in the past fallen less often than share prices, partly because owners, loth to accept a capital loss, delay selling. The volume of sales, rather than prices, tends to shrink. But times may be changing. The Royal Institution of Chartered Surveyors has found that some homeowners in London, worried about wobbly house prices, are selling and renting, in the hope of locking in a profit before prices fall. Who said bricks and mortar were safe?