An Investigation Into The Housing Market

a fundamental economic inquiry
Maurits van der Vegt
TVE Studio 2010

Maurits van der Vegt The Housing Market
An investigation into the housing market
A fundamental economic inquiry
Student: M. van der Vegt

Student id: s0506508
Course: Master thesis
e-mail: maups_adres@hotmail.com
e-mail: m.van.der.vegt@umail.leidenuniv.nl
1
Contents
Tables 3
Figures 3
Introduction 5
Part I: Exploring the Theoretic World
Chapter One: A Rollercoaster of Economic Theory 11

Chapter Two: Theorizing The Housing Market 32
Chapter Three: What About Bubbles? 51
Chapter Four: A Framework for Analyzing the Housing Market 63
Part II: The case studies
Chapter Five: Introducing the American and Dutch Cases 72

Chapter Six: Boom and Manias 116
Chapter Seven: To Fall or not to Fall 136
Conclusion: Where Are The Regulators? 152
Bibliography 157
Appendix A – American Historic Data 166
Appendix B – Dutch Historic Data 170
2
Tables
Table 1 – American Housing Cycle 74
Table 2 – Dutch Housing Cycle 76
Table 3 – Acceptable mortgage-income ratio 112
Figures
Figure 1 – Dutch and American House Price Indexes 73
Figure 2 – Herengracht Index 75
Figure 3 – American Housing Prices – GDP, Inflation, and Unemployment 83
Figure 4 – American Housing Prices – Income and Leverage 85
Figure 5 – American Housing Debt and Leverage 86
Figure 6 – American Housing Stock and Number of Households 87
Figure 7 – Gap Between Number of Households and Housing Stock 88
Figure 8 – Percentage Change American Housing Stock and Nr. of Households 89
Figure 9 – American Housing Index and Real Building Costs Index 90
Figure 10 – American Housing Prices – Affordability and Interest 92
Figure 11 – American Housing Prices and Rent 93
Figure 12 – American Housing Prices – Rent Model & Supply-Demand Model 94
Figure 13 – Dutch Housing Prices – GDP, Inflation, and Unemployment 99
Figure 14 – Dutch Housing Prices – Income and Leverage 100
Figure 15 – Dutch Housing Debt and Leverage 101
Figure 16 – Dutch Housing Stock and Number of Households 102
Figure 17 – Gap Between Number of Households and Housing Stock 102
Figure 18 – Percentage Change Dutch Housing Stock and Nr. Of Households 103
Figure 19 – Dutch Housing Index and Real Building Costs Index 104
Figure 20 – Dutch Housing Prices – Affordability and Interest 105
Figure 21 – Dutch Housing Prices and Rent Index 106
Figure 22 – Dutch Housing Prices – Rent Model & Supply-Demand Model 107
Figure 23 – American House Price – Income Ratio 110
Figure 24 – Dutch House Price – Income Ratio 111
Figure 25 – American Housing Prices and Consumer Confidence 117
Figure 26 – Dutch Housing Prices and Consumer Confidence 117
Figure 27 – American Housing Boom of 1971 to 1973 119
Figure 28 – American Housing Market and Consumer Confidence 119
3
Figures (continued)

Figure 35 – Dutch Housing Boom of 1971 to 1973 125
Figure 36 – Dutch Housing Market and Consumer Confidence 125
Figure 45 – American Housing Bust of 1973 to 1975 136
Figure 46 – American Housing Market – Unemployment and Consumer Confidence 137
Figure 51 – American Housing Flat Period of 1993 to 1996 141
Figure 55 – Dutch Housing Flat Period of 1974 to 1975 144
Figure 56 – Dutch Housing Market – Unemployment and Consumer Confidence 145
Figure 57 – Dutch Housing Bust of 1978 to 1985 145
Figure 59 – Dutch Housing Bust / Flat Period of 1990 to 1991 147
Figure 61 – Dutch Housing Flat period of 2002 to 2003 148
Figure 63 – Dutch Housing Bust of 2007 to 2009 149
4
Introduction
“There is perhaps no beguilement more insidious and dangerous than an elaborate and elegant
mathematical process built upon unfortified premises”
(T.C. Chamberlain) 1
“25-standard deviation events, several days in a row”

(Hedge fund manager about the reason of its fund’s losses) 2
Economics has evolved markedly since early economic thinkers like Hume, Smith and Ricardo.
Many economists have tried to add their own view, while the economic branch became
mathematically mature and nowadays sees many specialities under its umbrella definition. There are
macroeconomists or econometrists, statisticians (actuaries and so-called “quants”), financial
specialists, monetarists, business economists, and many others. Most specialties are also split
between the academia and business world, which are two worlds that show much less interaction
than might be expected. The business world has strongly embraced the Efficient Market Hypothesis
and its twin brother Modern Portfolio Theory. Probabilities and statistics are the core aspects of this
orientation. The academia on the other hand has retrenched itself in its specific specialties.
Macroeconomics is far more influenced by Keynes than some would like to admit. The aggregate-
demand-and-supply models (AD/AS models), widely used by central bankers, are evolutions of the
early Keynesian theoretic framework, only adjusted with new findings. The biggest discussion is still
the role of money and the working of markets, with (New) Keynesians 3 opposing the (New)
Classicists 4. Other specialists like finance and business economics are strongly founded in the
Efficient Market Hypothesis, with supporters like Samuelson. But we find more schools of thought,
like the institutional economics, which is attached to the Keynesian side. Accountancy on the other
hand is far more based on efficient market hypothesis (especially their use of specific asset valuation
techniques). The result is therefore a mismatch between the micro- and macro-economists, where the
macro-economists are ever more disillusioned by the classical dichotomy and its empirical problems
1
D.W. Hubbard, The Failure of Risk Management (Hoboken 2009) 167
2
G. Cooper, The Origin of Financial Crises (Petersfield 2008) 10
3
There are different ways to name the main schools of thought. I have chosen to use capital letters and indicate
evolutions of earlier strands with New instead of Neo, which results in New Keynesians and New Classicists. The term
Classicists, as used in this paper, has been taken from the book Modern Macroeconomics by Brian Snowdon and Howard
Vane. Other terms are Classical economists, Neo Classical Economists or Neoclassical(s). These all are the same as the
Classicist or New Classicist term used in this thesis.
4
B. Snowdon, H.R Vane Modern Macroeconomics. Its Origins, Development and Current State (Cheltenham 2005) 695
- 706
5
(and moving towards other models), while the rest of the economic profession is still mostly
supporting the Efficient Market Hypothesis and its link to (New) Classical economics.
The progress, partly due to this patched network of academics and professionals, on the
micro- macro-mismatch is not very well researched. Each speciality seems to have retreated to its
own domain, which leaves policy makers with many different and incompatible “solutions” and
frameworks. The best example of these problems is the Basle Accord by the Bank of International
Settlements (BIS). The basic tools prescribed by the BIS are based on statistical models and business
structure influenced by the financial and business economics, while their problems are often systemic
of nature (which should direct attention to the fundamental assumptions).
Therefore this thesis addresses the empirical experience of asset bubbles (in this case housing
bubbles) within the economic debate as linked to policy outcomes. The derivative main thesis
question is restricted to find the main culprit behind the bubbles: is deregulation or monetary policy
the main cause for the creation of housing bubbles. This question can be retraced to the overall
discussion between the Keynes-based theories, with its emphasis on structural problems, and the
Classicists, who focus on excessive money creation (as money is just a veil over the real economy).
This paper is divided in two parts, a theoretical Part I and an empirical Part II. The theoretical
part will provide the basic framework how to interpret the empirical figures of Part II. This is more
than a standard framework as I will try to place this thesis within the current theoretical debate,
expressed by a discussion of all relevant theories and my own perspective on the debate and the
theories.
Part I will start with the macroeconomic theories to provide not only a historical overview of
the different macroeconomic schools of thought, but also to point the reader towards essential
theoretic elements that are essential to come to a comprehensive understanding of bubbles in general
and the housing market specifically. The macroeconomic schools of thought will be discussed by
presenting the views of each of them towards the main elements of macroeconomic theories (market,
prices, money, long- vs. short-run and micro- versus macro-economy) and a short comment about
bubbles within these theories.
The findings of chapter one will offer a direction of research for chapter two, where I will
delve into the specifics of the housing market. Chapter two will present the micro-economic
perspective of the housing market, but also with links to the macroeconomic discussion of chapter
one. The findings of chapter two will include the market structure and main parameters of the
housing market as well as a perspective on fundamentals of housing prices.
The third chapter will turn specifically to a discussion about bubbles. It will discuss relevant
theories about bubbles and also a more specific discussion of bubble theories within the housing
6
market. With bubbles being essentially a form of “extreme” price deviations, it is naturally linked to
chapter two that relates to the market structure, as well as the fundamentals.
Chapter four will take all elements of the first three chapters together in order to present an
analysing “framework” for the empirical Part II. This chapter will be the link between the theoretical
discussion of the housing market and the empirical figures as presented in Part II.
Part II offers a comparison between the American and Dutch housing markets. The choice for
these two is mainly the existence of housing bubbles in both countries, while the American market
has crashed, the Dutch market, after a bubble in the late 1990s, has only seen overall slow price
improvements during the 2000s, but no real crash. The case study will discuss the housing markets
on an overall basis, but will also focus on three identified parts, the boom period, the downturn and
the flat period.
Part II starts (chapter five) with analysing the two housing markets by way of the framework
presented in chapter four, which will encompass a short introduction of the structure of both markets,
the identification of periods of booms and busts and the long-term trends and fundamentals of both
markets. Chapter six and seven will focus instead on the specific periods of booms and busts and the
parameters behind the price changes.
Chapter eight will be the concluding chapter with an overview of the findings, an answer to
my thesis question and a perspective on how this thesis fits within the economic theories to complete
the picture of my research.
Finally, I want to make clear to the reader that my ultimate goal is to analyse the housing
market of the United States and the Netherlands over the past 40 years. Although I will review a lot
of economic theory, there is a difference with more economically oriented papers. My goal, as a
historian, is to understand what happened in the past, while an economist ultimately wants to be able
to tell how the housing market will react in the future. This has consequences for my appraisal of
some economic theories. Take for example the effect of uncertainty versus risk, where uncertainty is
based on the unpredictability of the future. Although this might be a real obstacle for economists, for
a historian it is less of an issue, which might make me elaborate less about its consequences, than an
economist would deem necessary. But I still hope, that understanding what happened in the past can
shed some light about the theories economists use to predict what might happen in the future. In that
sense, this paper is part of the economic debate.
The second part of this introduction gives some insight into the current discussion about the
asset markets (of which the housing market is an example) and its influence on the economy. I focus
here mainly on the issue of asset prices on monetary economics, as it best illustrates the current
knowledge gap (uncertainty about the exact role of housing within the economy and its relationship
7
with other economic parameters) that seems to exists with policy makers. In my conclusion I will
return to this debate and what this paper might add to the discussion.
Asset Prices and Stabilizing Economic and Monetary Policies

Policymakers and economists are slowly accepting that asset bubbles can be destabilizing
phenomena and should therefore be addressed by policymakers. This changing view is the direct
result of current financial crisis and its main culprit the American housing market. But this is not the
only reason. Bubbles are not only gaining interest, they seem to become less exotic and more real.
Beside the asset bubble in housing, we have seen many other bubbles during the last 30 years. To at
least the perception of many commentators, there have been bubbles in almost any kind of asset from
stock markets (dot.com bubble, Nikkei bubble) to bonds (junk bond crisis of the 1980s), from
residential housing (subprime crisis) to commercial property (Australian property crisis of the
1980s), and from oil (2008 oil boom) to rice (2007 food crisis 5).
These bubbles not only create economic disturbances (higher oil prices slow down economic
growth), but they can also result in far more damaging social unrest. It is therefore no surprise that
policymakers are now refocusing on asset markets, albeit with much hesitation. 6
At central banks the acceptance that asset markets fluctuations has effects on their own
objectives is seeping in from different channels. Although the assertion that bubbles exist is still
being discussed, the impact of the price fluctuations on financial stability cannot be denied.
Containing this systemic risk depends on how the nature of the systemic risk is assessed and there
are many different opinions. Some blame the structure of financial systems (i.e. the set of policies
and laws), where policies like mark-to-market or Basel II have been receiving much criticism for not
containing the problem, or even making matters worse. 7
Another way asset bubbles have entered the discussion is the way inflation statistics are being
conducted. Doubts have arisen from the experience of low inflation (based on a Consumer Price
Index) with high asset price inflation. The question raised is why the asset price inflation did not
have a significant impact on core inflation figures, but also if “asset price inflation” should be a
separate parameter to be used. 8
5
J. Piesse, C. Thirtle, ‘ Three bubbles and a panic: an explanatory review of recent food commodity price events,’ Food
Policy 34 (2009) 121
6
S.G. Cecchetti, ‘The Brave new World of Central Banking: Policy Challenges posed by Asset Price Booms and Busts,’
National Institute Economic Review 196 (2006) 107
7
C. Goodhart, ‘Is a less pro-cyclical financial system an achievable goal?,’ National Institute Economic Review 211
(2010) 17
8
S.G. Cecchetti, ‘The Brave new World of Central Banking: Policy Challenges posed by Asset Price Booms and Busts,’
National Institute Economic Review 196 (2006) 107
8
A third way housing prices have entered the debate are the wealth effects, and its derived
consumer effects, of volatility in asset prices. 9 Especially with regards to the almost universal way of
gearing up housing investment (i.e. high debt-to-value ratios), where the owners are especially
vulnerable to price declines. The result of asset price declines might be a sudden drop in consumer
demand with possible devastating effects. 10 Instead of demand side effects, others point towards the
supply side effects of a credit crunch that often accompanies a debt-deflation situation. 11 The third
option is to look at the micro-economic elements of macro-economic effects of asset prices. 12
Much of the discussion expresses itself in the way of researchers adapting current mainstream
models, either to have the asset price volatility play a bigger role in economic models, or to devise a
way for policymakers to react to asset price volatility. 13 These discussions, as the ones above, are
primarily macro-economically oriented, often with no distinction between types of assets. 14 Other
economists are oriented towards microeconomic models, but the link between microeconomic and
macroeconomic models is more often than not non existent (in theory as well as between
practitioners, who have their own departments, journals, etc).
In short, the housing market does matter, but researchers are uncertain about how and when.
Also the problem is approached from different angles, that represent the researchers own background
(accountancy versus monetary economics, for example) or from different theoretic schools (New
Classicists versus New Keynesians, for example). This paper does not place the housing market
within these models, but by analyzing the workings of the housing market from a macro and micro
perspective might help the implementation of the housing market into these models.
9
F. Kajuth, ‘The role of liquidity constraints in the response of monetary policy to housing prices,’ Journal of Financial
Stability (2010) 2
10
B. Bernanke, M. Gertler, ‘Monetary Policy and Asset Price Volatility,’ Economic Review of the Federal Reserve Bank
of Kansas City (1999) 17-51
11
C. Bean, ‘Asset prices, financial instability and monetary policy,’ American Economic Review 94:2 (2004) 15
12
F. Kajuth, ‘The role of liquidity constraints in the response of monetary policy to housing prices,’ 5
13
C. Goodhart, ‘The Boundary Problem in Financial Regulation,’ National Institute Economic Review 206 (2008) 48
14
F. Kajuth, ‘The role of liquidity constraints in the response of monetary policy to housing prices,’ 2
9
PART I
Exploring the Theoretic World
10
Chapter One: A rollercoaster of Economic Theory
Economic theory is less straightforward than most outsiders sometimes think and most handbooks
pretend. The professionalization of economic science over a century ago has not resulted in a
unanimously accepted basic paradigm and theoretic framework 15. Especially at the level of the
macro-economy, there are vast differences of opinion about the processes and functions of
economics basic elements (i.e. the market and money).
If we want to understand the phenomenon of bubbles we first need to understand the broader
economic debate about the structure of the economy and its basic elements. Not only is the
interpretation and analysis of bubbles rooted in this debate, the current regulatory framework and
monetary policies are also a result of this debate, which makes it a necessary starting point.
I will also use this chapter to make clear my own standpoints within this debate. Making your
own position clear within the broader debate is something that is not standard business, where
researchers focus on their own specialities without mentioning their basic assumptions and its place
in the broader debate. This sometimes creates the image of a cohesive thinking within economics,
which creates the possibility for policymakers to take economic thinking hostage, like for instance
we lately have seen with the current climate debate, or the fact that “the economists” get the blame
for the current financial crisis. Science is about discussion, disagreements and asking questions, that
is the way how science progresses. Researchers should protect this debate, starting by acknowledging
the differences in opinion.
The specific discussion about bubbles has also been directly affected by the different basic
assumptions between the different schools of thought. Therefore I start this chapter with identifying
in paragraph one the major differences in the broader economic debate. In the first paragraph I will
discuss a history of macroeconomic thinking. I will focus the discussion on five basic elements of
economics and bubbles as an added six element. After a short introduction of the specific school of
thought, I will review the six elements, starting with the view on how markets work, followed by the
view on prices and price determination, of course money is essential and will be the third element. In
order to get a better understanding of the characteristics of each school of thought and the differences
between them, I focus on the long-term versus short-term elements in each school, as well as the link
15
Most economic books struggle with this omission, either this lack of unanimity is ignored, for example in Oliver
Blanchard macroeconomics handbook. Another example is ‘monetary economics’ by M.K. Lewis and P.D. Mizen, who
presents a comprehensive overview, but it fails to separate clearly the differences between theories, which leaves an
chaotic overview of theories without a clear direction. This leaves the interested reader to add an historical overview of
macroeconomic thought to discern the many different opinions, like the book I used ‘Modern Macroeconomics’, by
Brian Snowdon and Howard Vane, in order to get a clear and thorough overview of the relevant theories. Of course
supported by more specialist books and articles.
11
between microeconomic and macroeconomic views. As the final point a short perspective of each
school towards bubbles.
In the second paragraph I will present my own view on these different schools of thought, as well
as a set of elements that I deem essential to review in the second chapter when the housing market
will be analysed from a theoretic perspective.
1.1 A history of macroeconomic theory 16

I focus my discussion especially on the period after WWI, but start with the classical economic
theory developed in the one and a half century before.
The Classicists
The classical economic discourse has given some fundamental insights that we still use today.
Without much statistical evidence available, these economists were mostly theoretically orientated.
Despite the practical limitations these economists faced, they were able to provide a theoretic
framework, which was essential for the birth of the economic sciences. I will now discuss this
following the setup explained above.
The market
The macroeconomists were focused on the workings of free markets, with Smith’s famous invisible
hand, that brings supply and demand together (the economy is therefore inherently stable) 17. With an
automatically stabilizing economy short term fluctuations were deemed irrelevant, while the focus
was on long term growth. The economy was not seen from a closed economy only, as the economist
David Ricardo introduced the concept of comparative advantages and showed why trade is good, in
principle, for everyone involved (and therewith in the long run “destroyed” mercantilism). Ricardo
also influenced several principles, like Ricardian equivalence 18, which is an argument against
government expenditures, and for this paper his insights regarding the valuation of land. It took a
while before a comprehensive classical school of thought developed. It was Leon Walras who
translated the invisible hand and free market ideas into a mathematical framework. Leon Walras
introduced an equilibrium model based on an auctioneer principle that always and continuously
16
To avoid an oversupply of footnotes, please note that this entire chapter is based on the following books: M.K. Lewis,
P.D. Mizen, Monetary Economics (Oxford 2000); B. Snowdon, H.R. Vane, Modern Macroeconomics. Its Origins,
Development and Current State (Cheltenham 2005); O. Blanchard, Macroeconomics. 4th Edition (Upper Saddle River
2006); J.E. Stiglitz, B. Greenwald, Towards a New Paradigm in Monetary Economics (Cambridge 2003); M. Altman
edit., Handbook of Contemporary Behavioral Economics. Foundations and Developments (New York 2006)
17
B. Snowdon, H.R. Vane, Modern Macroeconomics, 37
18
Ibid., 111-112
12
clears and is based on Say’s law, that states that supply creates its own demand, with the result that
the economy will always be in equilibrium.
Prices
Prices play a central role in the classical theories. As markets are efficient, demand and supply are in
equilibrium at a specific price. A market price is therefore the price that results in the clearing of
markets. The Walrasian system was in fact a barter economy with relative prices to each other (real
prices). The classical system splits the assessment of real prices, that are prevalent in the Walrasian
barter system, while the nominal prices are the result of the introduction of money. It is important to
note that Say’s law, the quantity theory of money and the Walrasian system all inhibit a certain
assumption. That assumption states that supply determines aggregate output and supply itself is
subsequently affected by the interest rate. This makes the interest rate crucial, but in the classical
theory interest is of course not set by anyone, instead classical economists argue that the interest rate
is the result of the demand for investments and savings. 19
Money
The Walrasian system was in fact a barter economy with relative prices, but even though relative
prices are relevant, we live in a monetary economy. The quantity theory of money (developed in
Cambridge (UK) and Chicago 20) provided the link between the real economy, as described by
Walras, and the monetary economy, which result in nominal prices (the standard theory, in US terms,
is written as M*V = P*T, or money stock times velocity equals prices times transactions). Monetary
based inflation would drive up all prices in the Walrasian system on a weighted basis and would
therefore not have real effects (higher prices would not result in lower demand or higher supply) 21.
So money was neutral. Real inflation was of course possible in sub-markets (or even all together),
due to higher demand than supply.
Long-run/short-run
The classicists ignored short-run fluctuations, but were interested in long-run fluctuations as
described by business cycles and of course long-run growth of the economy. The latter not without
reason, as slightly higher growth rates result in major improvements in real income in the long-run
19
B. Snowdon, H.R. Vane, Modern Macroeconomics, 71-72
20
Ibid., 61-63; The Cambridge school is best known by its proponent Alfred Marshall and the Chicago school is best
known by its proponent Irving Fisher (Chicago adopted Fisher’s theory, but Fisher was a Yale professor). Both
developed somewhat similar ideas based during the late 19th and early 20th century. Their ideas were the start of a specific
strand of macroeconomic theory, but not new as the development of this theory can be traced back via John Stuart Mill to
earlier thinkers like John Locke, Cantillon and David Hume.
21
Ibid., 71-72
13
(the divergence between rich and poor countries is often linked to this cumulative effect 22). As the
economy was inherently stable, short-run fluctuations were ignored 23.
Micro-macro economy
The beauty of the Classicist theoretic school is its elegant set of theoretic models that encompass all
levels of the economy. With the Walrasian system in place, most economists before Keynes were
focused mostly on microeconomic research (Robertson, Pigou, Hayek), with a micro-economically
dissenting group of the Austrian school (represented by Hayek). But furthermore the microeconomic
foundations were based on the maximizing behaviour of economic agents, which resulted in the
stable equilibrium state of the macro-economy.
Bubbles
In principle bubbles are not possible in classical theory. But some Classicists saw the theory as
relatively rigid and accepted the possibility of short-term money non-neutrality. So short-term
deviations from the ideal outcome were accepted by some classicists, with some possibility for
bubbles. These deviations focused mostly on distortions from government policies, as well as simple
fraud by economic agents. Still, the deviations were considered to be temporary and in the long-run
irrelevant.
Keynes and Orthodox Keynesianism

As is widely known, Keynes presented a radical departure from these classical theories. He argued
that many of their assumptions were not reflected by actual experience, therefore he created an
entirely new view on the economy, although it was completely macro based. With the experiences of
the Great Depression and the compelling arguments by Keynes, pushed many researchers into the
Keynesian school. One further note is that in this section I will reflect on Keynes mostly in the
orthodox Keynesian fashion as developed between 1936 and 1965. Several researchers, though, did
not agree with the interpretation of many orthodox Keynesians. Some critics, like Axel Leijonhufvud
are New Keynesians, but more radical positions are taken by Post Keynesians, who see themselves as
representing what Keynes really argued for (Post Keynesians will be discussed later in this chapter).
22
A.G. Kenwood, A.L. Lougheed, The growth of the international economy 1820-2000 (London 1999) 324
23
Snowdon, B., H.R. Vane, Modern Macroeconomics (Cheltenham 2005) 37
14
The market
Although Keynes’s General Theory was mostly descriptive and only supported by a few
mathematical models, shortly after publication Hicks introduced the so-called IS/LM model as the
mathematical interpretation of Keynes’s theory. The Investment & Saving (IS) relationship is a short
description for the real economy, while the Liquidity-preference & Money (LM) relationship is the
monetary side of the economy. 24 Keynes argued that equilibrium in the economy was reached only
with full employment, which in fact made him argue that the economy was most of the times in
disequilibrium and was inherently unstable. 25 The instability was the result of fluctuations in
aggregate demand (note that Keynes dismissed Say’s Law), where demand would not meet supply
(spare capacity). After these demand shocks the economy would not automatically return to
equilibrium, due to wage and price rigidities (i.e. markets are not efficient). Therefore this
disequilibrium effect needed to be corrected by government action, which due to some of Keynes’s
assumptions, should be pursued by fiscal policies, as he thought that monetary policies were mostly
ineffective. 26 He argued that monetary effects were indirect, in which monetary effects (note that
monetary policy is and was enacted through the supply of money) might have unpredicted
consequences. If we look at the quantity theory of money, a rising M might result in changing V, P
or Y, according to Keynes. 27
Concluding, Keynes did not believe in the Walrasian system that continuously clears, but
pointed towards coordination problems (wage and price rigidities) that would result in inefficient
markets, which in turn would need government action to return to equilibrium status. Please note that
the IS/LM model is controversial 28, although many (New) Keynesians still support it.
Prices
With wage and price rigidities Keynes absolutely did not believe in flexible prices. Changes in
wages, argued Keynes, would be very rigid in their downward pressure, but in the case of higher
supply or lower demand for labour this would not result in lower wages, which have as outcome
involuntary unemployment. Sadly, Keynes’s theory was only directed towards the aggregate level,
while the micro-foundations for the rigidities were not explored. It was even worse, due to the
24
Snowdon, B., H.R. Vane, Modern Macroeconomics, 103-106
25
Ibid., 144
26
Ibid., 109
27
This is a reference to the quantity theory of money or Fisher’s equation: M * V = P * T, where M is the money stock,
V is velocity (how many times the stock is used for a certain amount of transactions), P is the price level, and T is for
transactions, although it is also written as Y or real income. Classicists consider the V and the T to be constant, so putting
money into the economy would result to their theory directly into inflation, presented by P.
28
The New Classicists dismiss the IS/LM model entirely, as do many Post Keynesians and even several New Keynesians
(of whom some resort to adjustments to quantity theory of money). On the other hand it still has many defenders, who
argue that it might not be perfect, but is a workable and insightful model (Tobin, Mankiw) that is more applicable than
for example the Walrasian model.
15
‘neoclassical synthesis’, 29 the micro-foundations were classical in nature and therefore ignored many
of the assumptions made by Keynesians (they believed in efficient markets, flexible prices and
rational maximizing behaviour of economic agents).
Keynes gives more emphasis to quantities than to prices. 30 Something that is in stark contrast
with the Classicists, but with inefficient markets, prices are less relevant as New Keynesians would
point out (see section New Keynesians). For example, consumption is based on income and not on
interest, as with Classicists. Also Keynes argued that investment was not only based on the interest
rate (i.e. the cost of capital), but also on expected profitability. Expectations were, according to
Keynes, very unstable (“animal spirits”). Interest plays an entirely different role with Keynes, purely
the price for parting with liquidity, while Classicists argued that the interest rates were determined in
the real economy, due to thrift and the marginal productivity of capital. 31
Money
In 1958 the Keynesian economist Phillips introduced his Phillips curve, a statistical discovery that
argued there was a negative relationship between inflation and unemployment. 32 This would give the
Keynesians the mechanism to get to full employment by accepting a certain rate of inflation. The
Phillips curve was based on a statistical relationship, that was entirely based on empirical findings,
but had no theoretical underpinnings. A flaw that would open the door for the monetarists.
Long-run/short-run
Keynes’s General Theory was mostly short-run focused. Stabilizing short-run fluctuations (in
demand) became the focal point, while long-run growth was mostly ignored by Keynesians, although
Solow’s growth theory was adopted in the sense of the neoclassical synthesis. Post-war
Keynesianism started explaining business cycles from Keynes’s multiplier effects (changes in
investment influences income by multiple times according to Keynes). Which points towards real
effects causing business cycles (in contrast to Monetarists and early New Classicists).
Micro-macro economy
This is the area of the neoclassical synthesis. Keynes did not provide micro-foundations for his
macro-economic theory. The Orthodox Keynesians accepted the Classicist micro-foundations (under
29
B. Snowdon, H.R. Vane, Modern Macroeconomics, 21; The neoclassical synthesis was a way through which several
economists, most notably Samuelson, tried to reconcile Keynesian macroeconomics and classical microeconomics, this
reconciliation was called the ‘neoclassical synthesis’.
30
Ibid., 58
31
Ibid., 62
32
Ibid., 135
16
the banner of the ‘neoclassical synthesis’), a decision that they later would probably regret during the
new classicist revolution.
Bubbles
Keynes of course did not believe in perfect markets, but his theory was a macro-economic theory
without specific micro-economic specifications. But bubbles are normally confined to specific
market environments (housing market, stock market, commodities) and therefore in a micro-
economic sphere. On the other hand, his idea of rigidities, money non-neutrality and uncertainty
(preference for “safe” assets) can all be considered ingredients for bubbles.
Monetarists
There were several flaws in orthodox Keynesianism. As stated, it actually lacked any micro-
economic foundations, as the classical microeconomics were accepted as the mainstream theory.
Furthermore, the Phillips curve was based on statistical relationship, that was entirely based on
empirical findings, but had no theoretical underpinnings. Milton Friedman (not coincidently from
Chicago 33), started the attack or counterrevolution as it is generally called. The monetarists were
attacking specific elements and assumptions of Keynes, they did not attack the whole theory. That
would have to wait until the New Classicists came to the forefront.
The market
The monetarist argument rested on the role of money. Instead of Keynes’s non-neutrality of money,
Milton Friedman argued that money can have real effects in the short-run, but was neutral in the
long-run, or what he called superneutrality. 34 He reintroduced the quantity theory of money and
showed empirically that velocity was stable in the long run (in contrast to Keynes’s argument) and
that inflation was mostly a monetary phenomenon. 35 Milton Friedman never formally adopted the
Classicist assumptions, as he accepted short-run non-neutrality of money. But he did not accept long-
term money non-neutrality as that would imply long-term money illusion with economic agents,
which Milton Friedman thought was too absurd to assume. He therefore introduced expectations to
adjust short-run money illusion, or unanticipated inflation, but with long-term neutrality, as
economic agents adjust previous errors. The introduction of adaptive expectations (expectations
adjusted for past errors) 36 into models of economic relations was a major innovation by Friedman
33
As stated in the review of classical theories, the Chicago school is focused on the quantity theory of money. The fact
that Friedman was the one who revived this theory into mainstream thinking and that he is a proponent of the Chicago
school and affiliated to the University of Chicago, does make his orientation seem almost unavoidable.
34
M.K. Lewis, P.D. Mizen, Monetary Economics, 169-171
35
Ibid., 166-167
36
17
(Keynes also gave expectations an important role in his reasoning, but he argued that these were
unstable, with an unstable velocity as a consequence). Milton Friedman refocused on money and
without long-term money illusion argued that the Phillips curve was also incorrect in the long-run. 37
He adjusted the Phillips curve model with expectations and so to come to a “natural rate” of
unemployment (Later renamed by Keynesians (Tobin and Modigliani) into NAIRU, or Non
Accelerating Inflationary Rate of Unemployment). 38 At the natural rate of unemployment,
equilibrium was reached, or in modelling terms it could be called “full” employment.
Prices
Milton Friedman ignored real prices, as he focused on the role of money without a general theory. He
did make nominal price changes, in the long run dependent on money supply and not on rigidities
like Keynes.
Money
Milton Friedman made money central in his argument. The main argument was that the quantity
theory of money was not about income or prices (as Classicists and Keynesians argued), but about
the demand for money. 39 The demand for money was based on wealth constraints, return on money
versus other assets and the asset-holders tastes and preferences. 40 Rising money balances (resulting
from central bank open market operations for example), would create a shift in the portfolio of assets
until the marginal rate of return of all assets were equal again. This portfolio shift was the central
element for effects of money supply on the real economy (which were also temporary). Friedman not
only agreed that money could have short-run real effects, but he also argued that changes in the
money supply were also the major factor influencing nominal income, instead investments, which led
to variations in aggregate demand as stated by Keynesians. 41 Friedman argued that all recessions
were the result of changes in the money supply. 42 This was possible as he argued, that money
demand was stable, so only money supply could result in economic fluctuations.
Long-run/short-run
With the introduction of expectations Friedman cleared the way for the New Classicists. In fact
Milton Friedman argued that short-run demand management, as proposed by Keynes, would be
37
38
Ibid., 187
39
40
Idem
41
Ibid., 154
42
Snowdon, B., H.R. Vane, Modern Macroeconomics, 171
18
useless as the effects by higher government expenditures would be anticipated on by economic

agents and thereby eliminating the effect.
Micro-macro economy
Milton Friedman’s argument was based on the quantity theory of money, and an adjusted Phillips
curve and his natural rate hypothesis. All are macroeconomic concepts.
Bubbles
Milton Friedman’s attack on Keynesianism was also macroeconomic. It does have room for price
distortions in the short-run, as he held a believe of short-run non-neutrality. If there is room for
bubbles in Milton Friedman’s theory it is on nominal terms, as real effects should peter out quickly.
New Classicists & the Real Business Cycle

Milton Friedman made money central and introduced expectations, but the Monetarists are much
closer to Keynesians than their successors, the New Classicists. One of Milton Friedman’s students,
Robert Lucas, became the frontrunner of this reintroduction of Classicist macro-economics. With
expectations, Milton Friedman reached his natural rate hypothesis. Lucas took expectations further
(based on John Muth (1961)) towards his rational expectations hypothesis (in contrast to monetarists
adaptive expectations). 43 The term rational was brilliantly stated, as it made critics wary to reply
(how to reply to rational? Argue for something irrational?).
The Market
According to John Muth, expectations are actually informed predictions, but will also affect current
actions by economic agents and should therefore be central to any economic model. Robert Lucas
restated it to his rational expectations, which entailed that expectations are reached based on all
available and relevant information to come to the best possible guess of the future value of a
particular economic variable. 44 Errors can be made, but these are random and in statistical terms have
a mean of zero. 45 The rational expectations hypothesis is not the real contrast with Keynesianism (as
New Keynesians have adopted its principle). That contrast came with the reintroduction of a
Walrasian system. At any point of time economic agents reach optimal demand and supply responses
(as based on the optimization principle in micro-economics), which results in the economy being in
43
44
Idem
45
M.K. Lewis, P.D. Mizen, Monetary economics, 214
19
constant equilibrium. 46 In short, Lucas argued that macroeconomics should be based on micro-
foundations. 47 With the Neoclassical Synthesis, this was never the case with Keynesianism. Robert
Lucas “solved” this by returning and adapting Classicist macro-economics. The market is defined by
perfect competition in which all economic agents are price takers (prices are the result of supply and
demand equilibrium and firms, consumers and workers have no individual influence on prices).
Lucas argued that even the labour market was in equilibrium as he showed through a substitution
model where workers chose between work and leisure. Unemployment is therefore always voluntary
in new classical models (the return for work is for some workers lower than the “return” on
leisure). 48 An important consequence of economies being always in equilibrium is that the aggregate
demand fluctuations of Keynes did not matter anymore. Lucas shifted the focus back to aggregate
supply, which also proved to be a catalyst for the development of new growth theories.
Another result was the appearance of the Real Business Cycle school, which completely ignored
monetary influences (they dismissed Robert Lucas’s lagged adjustment to unanticipated inflation
based on transaction costs, as they dismissed transaction costs 49) and argued that fluctuations were
based on technology shocks (i.e. supply shocks) in the real economy. 50 Another important part of the
RBC was that they saw the underlying trend in the growth rate of the economy as very smooth, with
fluctuations around the trend with a statistical “mean of zero” (i.e. stabilization does not matter) and
the fluctuations are not structured, but show a so-called random walk. 51
Whatever its flaws, the New Classicists had a very elegant set of models. A Walrasian system
and quantity theory of money for macro- and monetary economics based on classical microeconomic
foundations. That was (and still is) what it makes it so compelling. Keynesians, and especially New
Keynesians do not have a complete set of models for every section of economics.
Prices
With the economy always in equilibrium and markets being efficient, the prices always reflect the
equilibrium of demand and supply. In short, the price is always the market price and is always the
“correct” price. 52 That is principle, but Lucas accepted that expectations would be based on
incomplete information (note the difference with New Keynesian imperfect information in the next
section), so the economic agent would have to decide if the experienced price rise was based on real
effects (higher demand) that would require more output, or that it was a monetary effect (inflation)
46
47
Ibid., 220
48
49
50
Ibid., 308
51
Ibid., 308-309
52
O. Blanchard, Macroeconomics. 4th Edition (Upper Saddle River 2006) 583
20
that would not require more output. The lag in information results in adjusting behaviour of agents
towards the natural rate, which will result in swings around the natural rate (Lucas argued that agents
do not adjust immediately to new knowledge due to transaction costs). 53
Money
Although Robert Lucas was a student of Milton Friedman, the influence of money in New Classicist
models was slowly taken away. Lucas’s rational expectations implied that money was always
neutral, but as even Friedman accepted, money supply can have real effects. Lucas therefore invented
his policy surprise hypothesis, in which unanticipated inflation will result in economic agents
incorrectly thinking the price changes were due to real effects. 54 Money supply was seen as creating
inflation and New Classicists also argued that governments have an inflation bias (higher inflation
brings them benefits), so they argued for a rules-based monetary policy (one that simply follows
rules), instead of a discretionary monetary policy (one that can react to unexpected shocks). 55 The
new classicists were essential in the reasoning behind independent central banks and their inflation
targets (=rules based).
Long-run/short-run
Although Robert Lucas had some short-run adjustment periods to unanticipated inflation, this
disappeared with the Real Business Cycle school. The fluctuations that the economy experiences are
random and unpredictable in nature and as they have “a mean of zero”, are irrelevant in the long-run
anyway. 56 The return to the Classicists school of thought, with some adjustments, was complete.
Micro-macro economy
Robert Lucas was very critical of the Neoclassical Synthesis which accepted a Keynesian
macroeconomic theory alongside Classicists microeconomic theory. Lucas has been essential in
presenting a comprehensive set of macro- and micro-economic theories.
Bubbles
Either from a macroeconomic point of view with Lucas’s Walrasian equilibrium system or a
microeconomic point of view with Eugene Fama’s Efficient Market Hypothesis 57, there is no room
for price distortions whatsoever, as prices reflect equilibrium. Just like Classicists, the only room for
distortions are government policies and fraud, but these are again only possible to short-term
53
54
Ibid., 242-247
55
56
Ibid., 330
57
An explanation of the Efficient Market Hypothesis is given in chapter two.
21
deviations, as the system is considered to be self-stabilizing. But as the empirical evidence is so

compelling in favour of bubbles, especially in stock markets, some have tried to implement bubbles
within a New Classicist structure, most notably the rational bubbles, although most dismiss rational
bubbles as a correct explanation.
New Keynesians & the “New Neoclassical Synthesis”

The 1970s saw the attack on Keynesianism by Lucas and the New Classicists. But Keynesians took
the critique of Lucas regarding micro-foundations serious and started research to create a Keynesian
micro-economic theory to supplement the macro-economic theory of Keynes. According to New
Classicists this was a useless effort as they considered Keynes’s macroeconomic theory
fundamentally flawed as well. But the New Keynesians have come up with several very compelling
and influential research findings, most notably with respect to imperfect markets and its
consequences.
The market
New Classicists based their argument on micro-economic foundations of perfect markets where all
economic agents are price takers. But New Keynesians argued that many markets have firms that set
their prices themselves (mostly based on a simple mark-up system). 58 As they are price setters, this
brings doubt about equilibrium in markets. Especially due to asymmetric information New
Keynesians showed that credit markets (mostly promoted by Joseph Stiglitz 59) and labour markets
are known for asymmetric information and are not known for elements of perfect optimizing agents
that have perfect information within an efficient market setting. 60 The result is that New Keynesians
have come up with all kinds of complex analysis of specific markets. The result is the mainstream
acceptance that goods, labour and credit markets are all imperfect markets, which all breach new
classical equilibrium assumptions.
On the other hand New Keynesians have accepted the rational expectations hypothesis,
although many New Keynesians do not see this as particular influential (Gregory Mankiw argued
that its influence was highly overstated and that the central element of New Classicists is their
Walrasian system with continuous market-clearing).
58
59
J.E. Stiglitz, B. Greenwald, Towards a New Paradigm in Monetary Economics (Cambridge 2003) 135
60
22
A last interesting result of the New Classicists counterrevolution is the acceptance of supply
fluctuations as well as demand fluctuations by New Keynesians. 61 Many New Keynesians have also
accepted growth theories and the role of technology in improving potential supply.
Prices
As a result of imperfect markets, prices are also less telling. The resulting market price is not the
result of equilibrium between supply and demand, but can be the result of institutional factors or
other complex market relationships. Joseph Stiglitz for example showed that banks will not accept
higher interest rates if the associated risk is even higher. Higher interest rates will result in costumers
with much higher risk (as they are the ones willing to accept higher interest rates), so the quality of
loans will deteriorate with higher interest rates. At a certain level the risk of default will be higher
than the interest rate and the bank will decide not to lend, 62 which is in conflict with New Classicist
assumptions.
Money
New Keynesians have also abandoned the nominal rigidities of Orthodox Keynesianism, especially
influenced by the Monetarist argument of long-term money neutrality and have introduced many real
rigidities (again most notably asymmetric information). 63 Also several researchers have pointed
towards the non-neutrality of money, at least in the short run. Therefore it is now widely accepted
that money has some non-neutral aspects, although the inflationary aspects of money supply are still
accepted.
Long-run/short-run
The Real Business Cycle school is mostly dismissed by New Keynesians as utterly wrong, 64 but the
idea of business cycles has gained interest with New Keynesians. The focus has been placed on so-
called stylized facts. 65 These are several economic factors, like industrial production, consumption,
business/residential/inventory investments, among others. Over a long period of statistical data they
have been given “directional” identities, for example consumption is pro-cyclical and coincident with
the cycle. Unemployment is countercyclical, but no clear pattern has been discerned. Any theory
about business cycles should explain the stylized facts correctly. A problem is that the explanation is
strongly dependent on the choice of particular assumptions in the model used. So models that explain
these stylized facts correctly can in practice exist, while their structures and assumptions are in
61
62
J.E. Stiglitz, B. Greenwald, Towards a New Paradigm in Monetary Economics, 104-116
63
64
Ibid., 341-343
65
Ibid., 306
23
complete contrast to each other (like real business cycle models and New Keynesian business
models).
Micro-macro economy
Due to Lucas assertion that Keynesianism lacked micro-foundations, New Keynesians focused on
formulating micro-foundations in support of the macro-economic theory of Keynes. They mostly
accept Keynes’s macro-economic theory, although a unifying macroeconomic theory that includes
the researched micro-foundations by New Keynesians has not been presented (or reached
mainstream academia at least).
Bubbles
New Keynesians are focused on micro-economics with imperfect markets in mind, or in short, they
accept, in principle, the possible existence of bubbles. As most New Keynesians were mostly
theoretically oriented, it was due to several more empirically based researchers to start the research
into bubbles (Robert Shiller, Charles Kindleberger, among others). Although bubbles are still a
relatively minor research area within the New Keynesian world, interest, especially after the dot.com
bubble collapsed (and even more so after the housing bubble in the US), has been rising.
Post Keynesians
The name does suggest a thesis that is in contrast with Keynes, but to the contrary, Post Keynesians
define themselves as the true followers of Keynes. They argue that Keynes proposed a far more
radical approach to economics. Especially Keynes’s arguments about uncertainty (which is entirely
unpredictable in nature in contrast to risk) was the central element in his theory. It needs to be noted
that the Post Keynesian group is highly heterogeneous and holds many different points of view. 66 So
I will give a short overview of certain central elements in Post Keynesian thinking, but will also
focus on Hyman Minsky, as his insights are currently mentioned in relation to the recession.
The market
The Post Keynesians argue that Keynes dismissed three Classicists principles to escape the
auctioneer economy and discover the “actual” economy. He dismissed the gross distribution
principle, where everything is substitutable for everything, as is the basis for the Walrasian system
and is the principle behind Say’s law. 67 The result is an inherently unstable economy, as Keynes
indeed argued. Another point stressed by Post Keynesians is uncertainty about the future. Instead of
rational expectations, which believe that the past can be used in statistical analyses to predict the
66
67
Ibid., 455-456
24
future, they argue that the true case of Keynes’s uncertainty is a future that is simply unknown and
not based on past results. Post Keynesians call this true uncertainty. 68
Although Minsky is considered to be a Post Keynesian (probably relating his stance on inherent
instability, and his bigger role for future uncertainty), his “Financial Instability Hypothesis” is
remarkably only micro-economically oriented, with the focus on the financial system. 69 He argued,
somewhat like Ben Bernanke, that the financial system acted as an accelerator (pro-cyclical). Hyman
Minsky put forward a description how a stable financial system would increasingly absorb credit to
support speculative investments. The stable system started with normal lending practices, where the
principle and the loan itself could be redeemed from the return of the investment. Good economic
prospects would attract speculators who finance investments with ever more debt. In the end some of
these speculators would resort to Ponzi schemes. The investments financed by Ponzi schemes do not
cover the interest or even the principle of the loan. These Ponzi schemes can only continue when the
investments deliver a capital return (the investment itself is worth more) or because new capital (debt
or investment) is found. When economic conditions deteriorate these Ponzi schemes are normally the
first to collapse. 70 The downturn that followed according to Hyman Minsky was more in the sense of
Fisher’s debt deflation (and not unlike the argument of Joseph Stiglitz). 71
Prices
In contrast to New Keynesians, the Post Keynesians still focus mostly on nominal prices. The reason
they give is that the actual world works with nominal prices and reacts to nominal prices. 72 Post
Keynesians argue that the non-neutrality of money does not imply money illusion, non-neutrality
means that “money is a real phenomenon”. Keynes argued that under true uncertainty there does not
exists a forward-looking real rate of interest, as the Classicists argue. Also Post Keynesians argue
that our economy is based on nominal contracts, not real contracts. According to Post Keynesians
these nominal contracts are irrational in a Classicist world. But these nominal contracts are essential
in containing true uncertainty. Nominal prices should be the focal point, while real prices are a
fictitious element from a purely theoretical world. 73
Minsky focused on speculation, where debt influences asset prices in upswings and downturns. The
asset prices are pushed upwards by more demand from speculative, debt financed, investors. The
liquidation of these speculative investments has a higher supply of assets during the downturn (debt-
deflation period).
68
Ibid., 463
69
M.S. Lawlor, ‘Minsky and Keynes on Speculation and Finance,’ The Social Science Journal 27:4 (1990) 435-436
70
P. Mehrling, ‘The Vision of H.P. Minsky,’ Journal of Economic Behavior & Organization 39 (1999) 139-143
71
Idem
72
73
Idem
25
Money
Post Keynesians argue that, as we live under true uncertainty, money is never neutral. The only way
money can be neutral, is if true uncertainty does not exist (which is in contrast to Keynes’s own
arguments).
Long-run/short-run
With such a diverse group it is difficult to give a unifying view, but with uncertainty given, the long-
run is unpredictable and therefore we are unable to foresee what is needed and should not focus on
it. 74 This brings us to the short-run focus of Keynes, which is also the focus of most Post Keynesians
and especially about the specific elements of short-run instability.
Micro-macro economy
Although Post Keynesians adhere to Keynes and therefore are mostly macro-economical oriented,
the group is very heterogeneous and therefore some have had a more micro-economic orientation.
Minsky, for example, was focused on the financial system, which implies a micro-economic
orientation.
Bubbles
It is no surprise that currently many market observers use the emblem of a ‘Minsky Moment’ to
describe current experiences. We have seen many ponzi schemes being discovered, either as
investment funds (Bernard Madoff), or as specific investment instruments (some adjustable rate
mortgages had the possibility to pay less interest than required with the gap between actual payment
and required payment being added to the principle loan). The frequent use of the term after the crash,
in contrast to before, does raise some doubt about the actual knowledge of Minsky’s theory with
these market observers. Minsky’s Financial Instability Hypothesis is in fact a description of a debt-
fuelled speculative asset bubble (with real effects). Although his thesis has been partly overtaken by
New Keynesians in the last two decades.
Behavioural economics
During the 1970s and 1980s a new brand of economics has arisen. Behavioural economics is based
on the assumption that it is necessary that the assumptions in economic analysis and models should
also be tested on actual experience, for example rational expectations. 75 It will be no surprise that
behavioural economics brings psychology into the economic discourse and that is not a moment to
soon. As for example research by the bank of England showed in 2003, which reported stark
74
75
M. Altman, Handbook of contemporary behavioural economics (London 2006) 80-81
26
differences of inflationary expectations between different groups of people (inflationary expectations

were influenced by age, geographical location and occupation, and housing status). 76 Also talking
about bubbles, terms like mania, euphoria, irrationality and others come up. So apparently behaviour
is important in explaining bubbles.
The market
Behavioural economics is mostly oriented on the assumptions used in economics, not with a specific
reference to any of the above mentioned mainstream schools. That said, most mainstream schools
sometimes do use somewhat similar models (for example the IS-LM model can be used to describe
the Keynesian, Monetarist and Classicist theories). The assumptions are at centre of the differences.
Let’s review an example. The role of saving is rather important in many economic models.
Classicists argue that the price for postponing consumption now is essential. 77 Keynes pointed
towards liquidity preferences, but these are either linked to income levels (transactions and
precautionary motives) or interest (speculative motive). 78 The marginal rate of return is also
important to Monetarist models. Most savings preferences are based on Fisher’s time preference
theory. 79 But Behavioural economists have found this principle very lacking. Not only has research
found that people are far more oriented to present consumption, also the temporal consistency (i.e.
saving preferences do change little over time) seem incorrect. 80 Furthermore, the differences between
people with different backgrounds (like the above stated example of inflation expectations) are very
significant and preferences even differ with different circumstances. 81 As saving is considered to be
important for investments in an economy, which in turn is essential for future growth paths,
economists might be wise to reconsider their assumptions. Overall, most research of behavioural
economics point towards frictions, lags, path dependency and the like. Therefore New Keynesians
and Behavioural economists do appreciate each others theories, while the Classicists are mostly
criticized for oversimplification, or outright wrong definitions of their assumptions (wrong in the
sense that they do not seem to coincide with actual human behaviour).
Prices
Equilibrium prices are very useful, as they hold a lot of useable information about specific markets,
supply and demand, and in longer-runs even trends in the economy. But with inefficient markets
prices become much less telling. Prices can be significantly influenced by specific market forces or
76
Bank of England, ‘Economic Models at the Bank of England,’ BoE Paper (1999) 2-8
77
M.K. Lewis, P.D. Mizen, Monetary Economics, 117
78
79
M. Altman, Handbook of contemporary behavioural economics, 297-298
80
Ibid., 299-300
81
Ibid., 301
27
even specific market players. Behavioural economics does not specifically delve into the realm of
price determination, which leaves us with the ambiguous price setting mechanism of imperfect
markets from New Keynesian models.
Money
People’s attitude towards money is of course very interesting. Keynes argued that “money matters”
as people give it some valuable attributes, in contrast to Classicists who argue against any form of
money illusion, as it is nothing more than a veil on the real economy. Again Behavioural economists
side with the Keynesians. People tend to value money for its own sake, not only as a representative
of possible consumption. 82
Long-run/short-run
Behavioural economists have mostly showed that preference for present consumption is high, but
that they will react different in different circumstances. 83 This presents economics with some
interesting afterthoughts. Uncertainty for the future becomes greater, as the past is not necessarily a
good predictor of the future. Also policy becomes far more difficult as circumstances can be
perceived differently by economic actors at different moments in time. Policy action that works in
the past, does not necessarily work in the future.
Micro-macro economy
Behavioural economics is differently oriented than the other discussed schools of thought. They
work on either the individual behavioural level or they look at groups, either small to very large.
These outcomes have consequences for assumptions in either micro-economic models or macro-
economic models.
Bubbles
Terms normally associated with bubbles, like manias and euphoria, seem very well placed within
behavioural economics. Price determination has been relatively well researched from a behavioural
perspective. Probably most popularly by Khaneman and Tversky (Khaneman received the Nobel
price in 2003 for his research), with their illusion of validity, which states that “people are prone to
experience much confidence in highly fallible judgment”. 84 This means that people use concepts that
are simply not reflected by empirical experience, but do still have profound confidence in it (an
example is the assertion by many investors that low price-earnings ratio’s have a higher return than
82
M. Altman, Handbook of contemporary behavioural economics, 291
83
Ibid., 309-311
84
Ibid., 709
28
high price-earnings ratios, while empirical research has shown that large p/e ratio’s often relate to
high returns). 85 Another relevant item is so-called “positive illusion”, or that people are biased
towards positive predictions. 86 Research has shown that professional investors are consistently
overoptimistic on the predicted returns of their own investments. Other research has pointed towards
the low intensity of analysis when we are optimistic, while we significantly up our analysis effort
when we are pessimistic.
1.2 Assumptions from macro-economic theory within this paper

As shown in section 1.1 there are many different strands of viewing the economy. Most notable is
the contrast between believers in perfect markets and those who do not. Much “empirical” research
from the past has shown support for all models, even those that are in strong contrast to each other.
This strange experience that contrasting models can both explain empirical events, can be attributed
to specific parameters (normally based on assumptions) used in these models.
Is there any consensus in macro-economics, today? Although a “New Neoclassical Synthesis”
has been proposed that combines New Classicist and New Keynesian theory, although the
elementary part of New Classicist has been dismissed (i.e. continuous market clearing), so in macro-
economics there seems to be a stalemate. The old IS/LM model is still dismissed by many, but
several New Keynesians still accept it as useful (like O. Blanchard, J. Tobin, G. Mankiw, among
others). But the micro-foundations of New Classicists theory and the main assumptions of the macro-
economic theory of New Classicists have also been under strong attack. So we are left with a bit of
uncertainty where macro-economics is heading.
So, although I like its theoretical and mathematical consistency, I personally dismiss
Classicists and New Classicists theories. Central elements of these theories, like continuous market
clearing, voluntary unemployment, perfect markets, perfect competition, money neutrality, are highly
controversial or even dismissed by mainstream economists. The most important reason for its
continuing appeal, in my opinion, is its mathematical consistency and the practicality of its
assumptions within current use of Portfolio Theory, while in contrast the critics do not have such an
elegant and comprehensive set of theories.
Both main theoretic schools of thought have their theories expressed in their own
mathematical models. The New Classicists have a less complex structure for their theory in contrast
to the New Keynesians, which translates into a more consistent and mathematically sound model. To
my opinion the best theory should be that which is best in translating the actual experienced
85
M. Altman, Handbook of contemporary behavioural economics, 709
86
Ibid., 712-713
29
economic circumstances within a workable theoretic framework. But even if only the usability of
each mathematical model is the yardstick for which is the best theory, I want to point out that this is
not automatically in favour of the more mathematical sound New Classicists models, as Joseph
Stiglitz and Bruce Greenwald concluded that New Keynesian models present better analytical results
than New Classicists models. 87
Another point I would like to make is related to the typical discussion of (New) Keynesian
versus (New) Classicists, as seen especially in many newspapers. This discussion is often focused on
the role and impact of government spending, with Keynesians seen as proponents of (continuous)
government deficit spending and Classicists arguing that government spending is always wasteful. I
think the main element dividing the two theories is not the success of government interference, but
the workings of the market. Changing our perspectives this way, we see New Classicists arguing that
markets are stable and efficient and New Keynesians arguing that markets can be unstable (not
necessarily all the time) and that markets are complex structures that work different per sector and
under changing circumstances. I think that much research done over the past decades has shown that
New Keynesians are right to argue that markets are unstable and that markets work in very complex
ways. How to react to this finding of unstable complex markets is a derivative question from the
main argument. And New Keynesians are also not in agreement with each other what the exact role
of the government should be, while there are few who would argue in favour of continuous
government deficit spending as being effective.
Finally, I think that the understanding that markets are imperfect and inefficient is not only
important for governments and regulators, but also for businesses and investors. If they want to make
a profit in the market, it is necessary to understand how the market works. Maybe not necessarily in
order to make a profit (as even monkey’s can apparently make money by trading stocks 88), but
certainly in order to understand the risks appropriately. As will also become clearer in the rest of the
thesis, I will base my further analysis on the New Keynesian assumptions, supplemented with
elements of Behavioural economics (which to my opinion, can be regarded as an extension of New
Keynesianism).
87
88
www.beursgorilla.nl
30
The next chapter therefore has to focus on several aspects of the housing market to find out
which theory is most appropriate for assessing the housing market. Does it work more according to
New Classicist theory or New Keynesian and therefore the chapter will have to investigate several
economic issues:
1) the (in)efficiency of the housing market:
Is the housing market considered to be efficient or not (efficiency in the terms of Eugene
Fama and his Efficient Market Hypothesis). If the market is considered to be inefficient, the
prices in the housing market are not equilibrium prices and that can have important
consequences for the assessment of price distortions.
2) The structure of the housing market:

I will construct on overview of the elements of the housing market in order to look for
economic relationships in the structure. If the market is considered (in)efficient, I should be
able to find market frictions (or rigidities as Keynesians qualify them).
3) The price determination process:

If bubbles are some sort of price distortion, we should also overview how economic agents
determine housing prices, not only market prices, but fundamental values as well.
4) Behavioural aspects:
All economic agents exhibit certain behavioural aspects. I will have to review all important
economic agents and how their behavioural aspects might influence market behaviour.
5) Micro/macro:
I will be looking at the micro level (i.e. the housing market), but will have to reflect to macro-
influences as well. So the links between macro and micro level should be given due attention.
Especially the influences of changes in general government policy should be considered
carefully.
31
Chapter Two: Theorizing The Housing Market
As we have seen in the previous chapter, the vision of different macro-economists has not seen
consensus about the crucial elements of the economy, namely markets and money. Now we need to
put this in perspective to our specific sector of interest, the housing market. So we start with
dissection the economic determinants of the sector. The first paragraph will, in a descriptive manner,
review all elements and economic agents that interfere with the housing market. I start with looking
from a micro perspective, followed by a section with a macro perspective and end with a summary of
the important elements. In the second paragraph I discuss some existing theories that are applicable
to the housing market, first I will discuss valuation theories and then theories about market structure.
The third paragraph functions as a conclusion of this chapter summarizing the main points of
interest.
2.1 The Housing Market: How to look at it?

The micro perspective will look at the level of the individual sale, while the macro perspective will
look at the aggregate level. In a descriptive manner I will try to capture the main elements of the
housing market in the first two sections, which will present the input for the third section in which I
summarize all main determinants of the housing market. These determinants will be an important
input for the analysing framework as presented in chapter four.
From a micro-perspective
Let us start simple. The housing market consists of people who want to buy and people who want to
sell houses. Seller and buyers reach a price they both agree on to make a transaction possible. All
those transactions at a certain moment in time define the housing market. Analysing the entire
population of transactions get you total turnover, average housing prices and the like. Important to
note is that the overall group is a heterogeneous group, not only by the quality and size of the house,
but the buyers differ as well (in age, income, wealth, preferences, etc). The agreed price is influenced
on the individual level by several factors. The reference price is normally based on recent sales in the
region, but also influenced by third parties like real estate agents and investors. The overall price
level is of course influenced by many other factors, like unemployment, GDP growth, etc.
If we look at the transactions than we see specific factors coming into play. First of all it
presents a swap of a house for money. The seller receives cash from the buyer and delivers a house
in return. The house can be an existing house, or a newly build house. Furthermore, there is not only
the sale of a house, it cannot be seen without the sell of land, not necessarily at the same time.
32
The buyer needs to present a large cash amount. To get this amount the buyer can save this
amount or borrow the amount (or a combination of savings and loans). A higher savings-rate might
therefore result in higher demand for housing in the future. But housing is primarily financed through
mortgages, normally totalling several times a buyer’s annual gross salary. The mortgage is a loan the
buyer in principle needs to pay back with interest over a period of usually up to 30 years. 89 The long
duration of the loan in combination with a high level of borrowing versus income means a high credit
risk (risk of default) for the lender, so the buyer needs to present the house as a collateral for the
loan. The collateral is not only a safeguard for the lender that he gets his money back, but also acts as
an incentive for the borrower to repay the loan (if the buyer does not want to loose his home). 90 The
amount the buyer can borrow depends partly on his ability to pay interest and instalment each period.
Normally a person is able to pay around 33 percent of his monthly income for either rent or a
mortgage, 91 so if you restate that roughly 30 percent of gross income is available for mortgage
related payments (considering 3 percent maintenance and taxes costs 92), you can see that a lower
interest rate will result in higher prospective borrowing. The mortgage is the link between the
housing market and the financial market.
The buyer can either be an owner-occupier or an investor. The owner-occupier is interested
not only in the future value of the estate, as after all he is investing, but also (and maybe more so) in
finding a house that fits his current and future preferences. 93 His preferences are the result of the
composition of his household (kids or not, for example), the distance to his employer, the level of
public services (schools, hospitals, etc) and the preference for specific living conditions (specific
leisure, like restaurants or playgrounds, etc). An owner-occupier normally buys a house to own it for
at least several years. An investor is only interested in the risk-return level of the investment. The
(possible) income of a house is from rent (note that there is never a 100 percent occupation level, as
the investor will experience periods that the house is not rented out) and expenses are capital costs,
maintenance costs, and administrative costs (including taxes). The risk is derived from the tenant,
like not paying rent, or damage to the property. Other risk are higher interest rates (higher capital
costs), counterparty risk (the bank recalling the loan, due to a banking crisis), and asset valuation risk
89
F.J. Fabozzi, F.P. Modigliani, F.J. Jones, Foundations of Financial Markets and Institutions. 4th Edition (Upper Saddle
River 2008) 500
90
T. Steijvers, ‘Collateral and credit rationing: a review of recent empirical studies as a guide for future research,’
Journal of Economic Surveys 32:5 (2009) 925
91
See for example: www.fharesearchcenter.com (fha stands for federal housing agency, see chapter five). The percentage
of mortgage payments (interest, amortization and other costs) versus income can vary with the mortgage originator and
specifics like guarantees and borrower-specifics (special regimes for low-income borrowers). Some researchers use lower
ratio’s, like in the report the following report they use a ratio of 28 percent: M. Collins, D. Crowe, M. Carliner,
‘Examining Supply-Side Constraints to Low-Income Homeownership,’ Harvard Working Paper (2001) 9
92
E.L. Glaeser, J.M. Shapiro, ‘The Benefits of Home Mortgage Interest Deduction,’ NBER Working Paper (2002) 12
93
M. Munro, S.J. Smith, ‘Calculated Affection? Charting the Complex Economy of Home Purchase,’ Housing Studies
32:2 (2008) 349 - 367
33
(the house could devalue). The yield, influenced by all factors, on the investment makes investing in
housing interesting or not and changes over time.
The seller of the house can be either an owner-occupier, who is selling in order to buy another
home, or a builder/investor, in it to make a profit. The owner-occupier’s situation will influence his
willingness to sell. If he already bought another house, he might be forced to accept a lower price if
he needs to avoid double mortgage payments. But if he waits to buy until after his current home is
sold, the seller might not be willing to lower the price at all. The same, in principle, is true for the
investor. A major element in the cost of an investor is having his capital locked up in an asset that
does not generate income. 94 In short, it is very expensive to hold on to a property longer than needed
(for renovation or building). In specific circumstances investors also might be willing to slash prices
to very low levels, just to free up the capital or limit losses. Price elasticity is therefore very
dependent on the specific circumstances (forced selling, or opportunity selling).
Now let’s take a look at what is being sold. It contains two parts, the house and the land. The
price of the house is, or should be, roughly related to the rebuilding cost of the house. Beside the
simple rebuilding cost, people can value other things as well. A house with historic value (like a
Georgian house in the UK) can be valued higher than a modern one with the same basic features,
because rebuilding these historic elements is impossible without a time machine. In that case it
probably enters the realm of art valuation, which is based on being (very) rare in combination with
high demand for its specificities (a “historic” shack is probably not so valuable). 95 On aggregate
levels this is probably less relevant as the overwhelming amount of houses is relatively modern
(build after World War II). 96 The land price is related to the favourability of the area. This is
influenced by the quality of its infrastructure, the proximity to (preferably high paying) employers
and the competition with commercial real estate. Local government policies are very important in the
development of certain areas, as they are responsible for infrastructure and for attracting and
retaining employers.
Finally the financial market aspect. The buyer could get a mortgage directly from a bank or
via an “independent” mortgage advisor. Either of the two will make an assessment of the maximum
amount that an owner-occupier can borrow for the lowest possible monthly payments. The owner-
occupier will normally look towards houses based on the knowledge how much he can borrow and
94
J. Birger, ‘They call them Flippers,’ Money 34:4 (2005) 83-86; Other major elements for investors are the transaction
costs, which makes long-term investment necessary (but ensuring an income from the property in order to at least pay the
carry cost (mortgage, maintenance, and other structural costs).
95
D.J. Hodgson, K.P. Vorkink, ‘Asset pricing theory and the valuation of Canadian paintings,’ Canadian Journal of
Economics 37:3 (2004) 630
96
American housing market: www.census.gov table Q2-H7: 80% of the American housing stock has been build after
1949. Dutch housing market: www.cbs.nl table - Woningvoorraad naar bouwjaar: 79% of the Dutch housing stock has
been build after 1945
34
will tend to borrow as much as possible (which might not be the optimal financial structure for him
personally), in order for him to be able to buy his “dream house” 97. An investor will himself assess
the optimal financing position (the ratio of debt and equity), which yields him the highest return,
while lowering the risk to a, for him, acceptable level 98. The bank or mortgage advisor will also
make an assessment, which will depend on the desire to hold a specific mortgage (with a specific
risk-return ratio) or on the expected level of interest for reselling the mortgage to security investors,
like pension funds (with their longer term liabilities are also interested in longer term assets, in
contrast to many banks). 99 If the bank holds the mortgage on its own books the desire to hold specific
mortgages will depend on the structure of its balance sheet. Has it a need for riskier assets or not. It is
even possible that if a bank has to much risk, it will defer any request for mortgages as it will only
invest in government bonds in order to lower the risk on its books. 100 The bank might also decide to
buy off the credit risk, by taking on an insurance on default of the borrower. If the bank resells the
loan into a security it will want to sell in a market with as many buyers as possible to get the best
price possible. In order to do this, it will have to lower the risk-return ratio, or in more popular terms
it needs an AAA-ratio from credit rating agencies. 101 Pension funds, mutual funds and other
conservative investors primarily invest in low risk assets, in short, assets with AAA ratings (For
example Dutch pension funds are not allowed to invest in assets that have a grade below A-level).102
A bank can lower the risk into a security by combining it with low risk assets, like government
bonds, or cover the credit risk with insurance (credit default swaps or government guarantees). In
short the bank will try to create an AAA security with the highest return possible to get the best
selling price possible. 103 The role of the credit rating agency becomes very important (they decide
on the AAA rating and are therefore very influential on the profit the bank makes on securitization),
which might result in an uneasy relationship as they are also being paid by the securitizing bank.
Although this need not be a recipe for wrong assessments or inherent bias, as it does not work any
different with statutory auditors (where outright fraud is an exception). 104
97
M. Munro, S.J. Smith, ‘Calculated Affection? Charting the Complex Economy of Home Purchase,’ 362
98
P. Cheng, Z. Lin, Y. Liu, ‘Illiquidity, transaction cost, and optimal holding period for real estate: theory and
application,’ Journal of Housing Economics 19 (2010) 109
99
K. Matthews, J. Thompson, The Economics of Banking (Chichester 2005) 137
100
Idem
101
F.J. Fabozzi, F.P. Modigliani, F.J. Jones, Foundations of Financial Markets and Institutions, 540-541
102
Idem
103
K. Matthews, J. Thompson, The Economics of Banking, 135
104
F.J. Fabozzi, F.P. Modigliani, F.J. Jones, Foundations of Financial Markets and Institutions, 541; P.A. O’Hara, ‘The
Global Securitized Subprime Market Crisis,’ Review of Radical Political Economics 41 (2009) 322-323
35
From a macro perspective

The supply of housing is separated into two parts. First we have the supply of existing housing. The
rest of the supply is in newly build houses. The total quarterly sales of new and existing houses
represents a turnover of around two and a half percent of total stock in the United States and about
half that figure in the Netherlands. 105 With existing houses, there is normally no distinction between
the house and the land, while with newly build houses the distinction between land and house is
often made. Land can be purchased by the builder (or investor), who resells it including a house (or
apartments). If the land is also newly build, the government will first have to create infrastructure
and divide the land in formally distinctive plots and also rezone the land into residential (if the land
is zoned as rural, or nature, the regulation and taxes are different and the building of residential
housing is forbidden, investors can of course buy rural land which they think will be turned into
residential zoning). The supply of housing is supported by a construction sector. The building cost of
a house is sometimes considered the fundamental value of a house. 106 During a period of a growing
population or when other forces create higher demand, a higher rate of supply is needed, which can
result in an expanding construction sector. During a housing crash, this might cause extra disruption
as the demand for new houses might drop below a certain long-term trend, even for longer periods,
resulting in rising unemployment in this sector during and after a housing crash. 107 The same effect
will be noticeable in other service industries to the housing market (real estate agents, mortgage
lenders, notaries, etc). 108
The demand for housing depends on several factors. Long-term trends depend on
demographic developments, like the rise of households (note that household changes might be
different from general population trends). If you have 10 million households, you will also need 10
million houses, and probably a bit more to smoothen the mobility. Housing demand is of course also
depending on the ability to buy, which is determined by several factors. 109 A rise in income
(assuming this rise is not very uneven) will result in a better ability to get a (higher) loan and
therefore demand will go up. As already mentioned, lower interest levels will also result in a higher
demand, due to better affordability of borrowing. Unemployment is also influential, as it will lower
the ability of the overall population to pay, with higher unemployment leading to less people able to
buy, lowering demand (also possibly leading to forced selling and higher supply, exacerbating a
105
U.S. census Bureau – historical census of housing tables; Kadaster, ‘quarterly reports’, kadaster (2000-2010)
106
P. de Vries, P. Boelhouwer, ‘Lange Termijn Evenwicht op de Koopwoningmarkt,’ Netherlands Graduate School of
Housing and Urban Research Paper (2004) 8
107
M. Corder, N. Roberts, ‘Understanding dwellings investment,’ Bank of England Quarterly Bulletin (Q4 2008) 397
108
Idem
109
K.H. Kim, B. Renaud, ‘The Global House Price Boom and its Unwinding: An Analysis and a commentary,’ Housing
Studies 24:1 (2009) 12-13
36
possible downturn). 110 Besides the ability to pay, the demand side for credit, the availability of credit
is important as well. 111 For example if loose monetary policy leads to a higher availability of credit,
then interest rates will be lower, but some lenders might, if they lower their risk assessment (as they
expect asset prices to rise), also lower their collateral requirements (so people can borrow up to 100
percent of the house value, instead of 80 percent). Demand is further affected by a substitution effect,
although this is a bit blurry. Instead of buying, people can prefer to rent (for example if house prices
are high relative to rents). Long-term this effect can be disregarded, as house demand (either rent or
buy) is based on household versus stock of total houses (including those owned by investors). On the
short term though, demand for houses to buy (which is the market here investigated) can be
influenced by a growing number of people preferring (or vice versa) to buy instead of rent, resulting
in a temporary rise in demand for houses, and a slump in demand for rented houses.
Government policies can also affect demand and supply. Government policies are enacted on
national, regional and local level. In the United States, for example, Fannie Mae and Freddie Mac 112
guarantee residential mortgages all over the U.S. Monetary policy is also enacted on national level
and can have profound effect on the general economy and therewith on the demand for housing.
Grants, for first home buyers for example, are not only pursued on national level, but also on state
level. Local and regional economic development matters as well. Detroit has seen its population
being halved since the 1960s, due to a crippling local (auto) industry. 113 On the other hand, Houston
has outgrown its oil orientation and was better placed to endure the current economic recession. 114
Detroit has a hard hit housing market, while Houston does not have the same housing problems (only
6 percent of people with a mortgage are in a foreclosure procedure at the end of 2009 against a
national average of 30 percent). 115 The same can be said of Europe, with a stagnant housing market
in Germany and booming real estate markets in Spain and Ireland, the latter two saw significant
higher economic growth before the current crisis. 116 High growth can result in a tight labour market
and force the government, like in Australia, to allow higher immigration. The result, with an inelastic
supply, will be pressure on the housing market. Finally the tax regime can have an effect on the
housing market. Changes in the level of income tax can affect the ability to pay interest and dampen
the amount people can borrow. But there is also direct taxation, like a transaction tax or a wealth tax
(for example people need to pay a tax of their income from their investments, like their house). In
110
R.J. Shiller, Irrational Exuberance (New York 2005) 16
111
G. Favara, J. Imbs, ‘Credit Supply and the Price of Housing,’ IMF Paper (2009) 19
112
See chapter five for a description of both of these organisations.
113
E.L. Glaeser, J. Gyourko, ‘Urban Decline and Durable Housing,’ Journal of Political Economy 113:2 (2005) 346
114
F. Sigalla, ‘Texas Finds Cover from U.S. Economic Storm,’ Federal Reserve Bank of Dallas (2008) 3-7
115
A. Katz, ‘The Lone Star Secret,’ www.cnbc.com, retrieved from http://www.cnbc.com/id/36134970/page/2
116
T. Conefrey, J.F. Gerald, ‘Managing Housing Bubbles in Regional Economies under EMU: Ireland and Span,’
National Institute Economic Review 211:91 (2010) 39-40
37
sum, the government acts on both macro and micro level and both monetary and fiscal policies. Both
directly enacted towards the housing market and others not, but with side-effects on the market
sentiment.
It is also important to note that not every effect on demand and supply is equal in impact and
duration. Demographics change slowly, but are one of the main driving forces of housing demand in
the long run. General income levels also change slowly, but determine the ability to pay on the long
run. On the other hand changes in gross income of all households is more volatile (due to
unemployment, tight labour markets, etc) and therefore can have a stronger effect in the short term is
well. This is of course due to the fact that supply of housing is very stable. 117 The existing housing
stock is large, while new supply is very low versus existing stock, because houses normally last, at
least, decades. A more volatile housing demand versus housing supply can therefore result in major
disruptions to the market. For example, during a recession housing demand collapses, leading to
lower construction, which leads to an undersupply to the long-term demand (due to demographics
and so on). When the economy starts to grow again, demand will pick up and move towards the
long-term trend (as young people stayed longer at home, now decide to move out) and demand
suddenly outstrips supply and first prices will rise faster and, with a time lag (due to market
frictions), will also lead to higher construction.
But why should housing demand collapse anyway? Normally a relatively small part of the
labour force becomes unemployed, and the overwhelming majority keep their job. Wages tend to
grow slower during recessions, but rarely falls and people who keep their job, normally keep their
salary at the same level as well. Still demand sometimes drops. The problem seems to be sentiment,
or expectations. 118 A fall in demand for housing during a recession, can result in stagnant or a
(minor) price decline. This will change peoples expectations away from price rises towards an
expectation that house prices will stay stagnant. This will deter investors, who want to invest to make
capital gains (not the ones who want to make money just from renting it out; these investor normally
differ on their investment time horizon), but will also result in people waiting for prices to get lower,
or waiting to see if they are not the ones losing their job. The supply of houses will not fall
immediately, but the danger is that the supply will come down to people who need to sell quickly
(because they have lost their job, due to a divorce, a job on the other side of the country, etc). 119 This
group tends to accept lower prices than “normal” sellers. With lower demand and equal supply, the
117
Ibid., 28
118
M. Martens, ‘De implosie van een woningmarkt,’ Tijdschrift voor Volkshuisvesting 6 (2009) 12
119
For example, the total amount of transactions has dropped from over 3 million per quarter in 2006 to just above one
million per quarter in 2009, which are levels not seen since the early 1990s (census bureau). But housing in foreclosure
procedure at the end of 2009 was close to 1 million homes. Although these foreclosed homes are centred in problem
areas like Las Vegas, the level of foreclosures versus total sales makes clear that selling pressures are likely to be very
high.
38
few buyers can cherry pick their new house and push the people who need to sell at distressed prices.
As the general housing price level is the result of all sales during a specific period, this can result in
the fact that most houses being sold are forced sales like above. These prices are fire sale prices. If
their share of total sales during a period rises, their influence on house prices tends to grow and it can
exacerbate the effects of declining housing prices.
The determinants of the housing market

From the overview above I will select several indicators that I consider important. Not only from the
descriptive part above, but based on theoretic underpinnings as well. I will look at five areas, supply
of housing, the demand for housing, the financing of housing, general economic conditions, and the
market functions (interest rate, elasticities, etc). The theoretic part will be discussed in the next
paragraph.
I will start with housing supply. We need the number of existing houses, for which the
amount of housing stock versus the number of households can give an indication of a long-term
trend. The number of new houses being build and being sold versus the long-term demand trend is
also interesting, but is more important for the link between the housing market and economic
growth, 120 than for the housing market itself. Government policies, especially the rezoning of rural
areas to residential zones can have a big impact on local prices and if changes are large enough even
on regional or national level, as land is one of the most restrictive elements in housing supply.
Existing house sales might also be interesting to assess a natural ratio of sales versus stock levels.
Beside the demarcation between existing houses and new houses, there is also supply of (and
demand for) holiday homes or second (and more) homes. This effect though will be eliminated by the
ratio of houses versus households as long as the number of people with more than one house remains
relatively equal.
The second area of interest is housing demand. Long term gross/national demand is based on
the number of households. If we consider the demand for housing not in number of dwellings, but
valued in currency, income levels, cost of capital (interest rates), user cost of housing, and building
costs are also relevant. Medium and short term effects on demand can be expected from the
(un)employment level, GDP growth and changes in the rent/mortgage ratio. As mentioned above
expectations also play a big role, although I will see this as a specific market function.
The financing of housing is mostly done through high gearing (maximizing the loan-to-value
ratio), so the availability of credit is an important indicator. Beside the availability of credit, the price
of financing (i.e. interest) is also influential. So the interest rate should be included as well. Any kind
120
M. Corder, N. Roberts, ‘Understanding dwellings investment,’ Bank of England Quarterly Bulletin (Q4 2008) 394
39
of financing is in the end related to the income of the borrower. So income levels are a crucial
element in the financing area. Not the entire income is available, so tax regimes are influential. This
means that changes in the tax regime will effect disposable income and therewith possibly the
housing market. Beside taxation, governments also stimulate the housing market through grants,
which increases availability. First home buyer grants and other subsidies can have, at least
temporary, an effect on the housing market.
General economic conditions, like GDP growth (which is itself influenced by the housing
cycle), but also inflation can play a role. High inflation can result in a move from investors to invest
in “inflation proof” assets, and housing is one of them. 121 This can result in heightened demand.
Inflation can have other effects, as high volatility can disrupt markets, as it disrupts expectations.
Beside economic growth, is job growth an indicator for overall housing demand, this might avoid
misinterpretations from GDP growth figures due to so-called jobless growth. The unemployment
figures are also an important indicator. Rising unemployment will lower demand, as well as possibly
rising the number of forced sellers. But probably the most important element where unemployment
does affect the housing market is through sentiment. As rising unemployment levels will make
people postpone large transactions until they are sure they won’t loose their job as well.
Finally we have to assess the specific market conditions. As we have discussed the general
house price level, mostly available through indexes, does normally not take into account regional
differences and the fact that it is a heterogeneous market, where houses differ in almost any aspect
imaginable, like size, age, maintenance level, luxury, location, etc. As I will use gross figures, I will
assume that these represent the general picture within the population, although I will sometimes
make clear that the heterogeneous aspects of the housing market can be influential. As the main
subject of this paper is the existence of bubbles in housing markets, we have to assess the elements
that play a role there. To assess a bubble we have to come to some fundamental price level, for which
several models exist (see paragraph 2.2). Some link it to the rebuilding cost of the house, although
this ignores the price of land (as do most models). Others see more in a relation between ownership
and rent levels. Although this can be skewed due to all kinds of price distortions (for example,
government caps on rent levels). Another way of looking is that supply/demand models can indicate
historic price levels (trend analysis). Beside a relationship between rents housing prices can also be
viewed in relation to other asset markets in which investors can choose to invest, like stock markets,
bond markets, and commodities. The housing market is directly linked to the financial market as it is
a money based market. So the working of the financial market, especially through financial
innovation, can have a significant effect on the housing market.
121
T. Oatley, ‘Central bank independence and inflation: Corporatism, partisanship, and alternative indices of central bank
independence,’ Public Choice 98 (1999) 400
40
2.2 Housing market from a theoretical perspective

Beside the general macroeconomic theories as discussed in chapter one, which is oriented on the
general workings of markets, price determinations and indicator relationships. There are also many,
more micro-economical based theoretical perspectives, which I will discuss here. I will start with
reviewing available asset pricing models to understand how fundamental values of housing can be
assessed. Afterwards, I will turn to theories about market structure.
Asset pricing models and the housing market

Bubbles can be considered as deviations from fundamental prices, unstable volatility in the price
mechanism, the result of changes in a multi-equilibrium environment, or many other theoretical ideas
as proposed by researchers. One element they all have in common is of course the price. So we start
looking for theories about housing prices, or more general asset pricing models. There are several
models, which I will discuss here:
1) Present Value model

The name of the model makes clear the idea. The present value of a determining factor (for
example rent) and its future cash flow recalculated to its current value. 122 The problem
becomes clear immediately, as not all asset investments have a cash flow element, for
example gold. For housing often the rent is used as a potential cash flow. 123 Others use user
cost of housing as a determining factor, as rent can be rewritten as a payment for the cost of
capital to finance the house, plus maintenance, plus a profit factor, and a risk factor (credit
risk, interest risk, market risk, etc). 124 Beside the problems surrounding the factors used in the
model, there are other problems, like duration issues and changes in future yield levels (will
interest rates change in the future and by how much, when and how often). 125
There are also some interesting adjustments to simple present-value models, like models in
which investor behaviour to price changes are introduced to create intrinsic bubble models in
which prices often deviate from fundamentals. 126
122
G.G.M. ten Have, Taxatieleer Vastgoed 1. 4th edition (Groningen 2007) 223
123
Idem
124
M. Hwang, J.M. Quigley, J. Son, ‘The Dividend Pricing Model: New Evidence from the Korean Housing Market,’
Journal of Real Estate Finance Economics 32 (2006) 221
125
F.J. Fabozzi, F.P. Modigliani, F.J. Jones, Foundations of Financial Markets and Institutions, 388
126
L.F. Ackert, W.C. Hunter, ‘Intrinsic Bubbles: the case of stock prices: comment,’ The American Economic Review
89:5 (1999) 1372-1375
41
2) Rent model (rent gap theory)

People have to choose whether to buy or to rent a house. If both markets are efficient and
flexible actual rents should equal (more or less) the imputed rent calculation. The imputed
rent is based on several factors: 1) the interest on the mortgage or the lost return/interest on an
alternative investment; 2) the house is subject to depreciation; 3) house owners must pay for
maintenance and repairs; 4) property tax owed; 5) house-owners bear a risk, which must be
compensated by a risk premium; 6) house owners can profit from potential capital gains; 7)
house owners can profit from a tax deductibility of the mortgage payment. 127
In equilibrium, agents are indifferent between two options of buying or renting and the
imputed rents are equal to the actual rents. The problem with rents as a determining factor for
fundamental house prices is that rents do not have to be fundamental themselves.
Furthermore, due to institutional circumstances, (in the short term) the rental market might be
disconnected from the buying market. Finally, the imputed rents are very much linked to the
housing price, so if house prices rise, the imputed rent will rise and there will be a rent gap,
where the “fundamental” value reflects the bubble, while the actual rents (which might not
react that quickly to rising housing prices) will remain at lower levels.
3) Supply & Demand model

Another approach is to see imputed rents as the outcome of a market for housing. Following
this market view, imputed rents are determined by the supply of and the demand for housing
(“S/D model”). Demand is influenced by the utility an individual derives from occupying a
house (utility function) and the budget restriction (hence, the individual income and the costs
for housing). Since each agent spends a fraction of his income on housing, the same applies
for the whole country. Hence, the aggregated demand for housing depends on aggregated
income and the imputed rent. 128 It is often assumed that the supply of housing units is fixed or
at least very inelastic. Often in these models a depreciation function is also included, although
this is often considered to be a function of the rebuilding cost of a house to eliminate effects
of land. 129
127
C. Hott, P. Monnin, ‘Fundamental Real Estate Prices: An Empirical Estimation with International Data,’ Journal of
Real Estate Finance Economics 36 (2008) 430
128
C. Hott, P. Monnin, ‘Fundamental Real Estate Prices,’ 433
129
Idem
42
4) Land based model

Instead of determining the present value by estimating future “income” from the investment,
some argue for different points of view. For example, the price of the house excluding the
land should be linked to the rebuilding cost of the house. Research has shown that actual
house prices, including land, do diverge much from this rebuilding cost. 130 So the price
divergence should therefore be found in the price of land. But what constitutes the price of
land? Most research takes us back to David Ricardo. He argued that the price of land is linked
to the productivity of land, as he compared the selling price of different farmland. 131 He
found that farmland producing higher yields is selling for a higher price. So we have to look
at the productivity of land. Here we again run into trouble, as residential land does not
produce anything. Commercial property is different. The price of rent cannot exceed the
possible income to be made by the tenant. But what determines the land price of residential
buildings? Land price is mostly based on land rent and that is commonly referred to as “the
economic surplus per unit of land per unit of time”. 132 So there is an income element,
although it might not be realised in an actual cash flow, as well as a cost element (it is about
surplus, not gross income), which again does not necessarily have to be realized in actual
cash flow figures. The ambiguity of this theory is also found in the part of real land rent and
potential land rent. 133 The potential land rent (which is the highest and best land rent possible)
might be substantially higher than actual land rent, which can lead to an appreciation in land
prices away from the real rent being paid. The problems is thus making a good assessment of
the possible future income of land.
5) Q-theory / Portfolio Theory

In contrast to classical investment theories (based on Marshall and Fisher) where investment
is appreciated by a difference between the internal rate of return and the interest rate,
Keynesians developed investment theories of their own. 134 Based on Keynes liquidity
preferences, Tobin created a portfolio model that is based on an assessment of actual asset
prices versus replacement costs. This model need not to be just based on Keynes as New
130
M.A. Davis, J. Heathcote, ‘The price and quantity of residential land in the United States,’ Journal of Monetary
Economics 54 (2007) 2595-2620
131
D. Albouy, ‘What are Cities Worth? Land Rents, Local Productivity, and the Value of Amenities,’ University of
Michigan Working Paper (2008) 1
132
E. Clarck, ‘The Rent Gap Re-examined,’ Urban Studies 32:9 (1995) 1493
133
Idem
134
J. Ciccolo, G. Fromm, ‘”q” and the theory of investment,’ The journal of finance 2 (1979) 535
43
Classicists have used the same principle under efficient market principles. 135 Tobin’s original
model is based on an average Q, while the New Classicist is related to classical micro-
economics and marginal rates of return, and therefore their model is called the marginal Q
(although many users of the theory refer to Tobin’s Q and than implement a classical view of
the economy). 136 The biggest difference between the models is the value of the pricing
mechanism, but the structure of the model from both theoretic perspectives are similar.
Furthermore it needs to be noted that this model is widely used by investors to assess possible
investments. The Q stands for the difference between the market value of capital and the
replacement cost. Opportunities arise if Q is lower than one, one means no opportunity, and
above one indicates overvaluation.
6) Efficient Market Theory Based pricing models

These models are based on Eugene Fama’s “Efficient Market Theory”, in which no market
frictions exist, there is full information available, and other elements of the (New) Classicist
theories 137. The asset pricing models are mostly Portfolio Theory based models in which the
investors make a risk/return diversification, based on Markowitz’s model.138 These models do
not take into account the fundamental value of specific assets, but are entirely focused on the
risk and return factors involved. In short, they assess the riskiness of returns of assets versus
risk-free assets to diversify different assets into a portfolio. 139 Some models do take
fundamentals into account, although even then these are mostly hybrid models that use
fundamentals as an extra factor in otherwise risk/return based models. 140 It is astonishing that
structural effects, like the existence of bubbles, is mostly ignored within these models. The
price these models use is the market determined price, which, using the Classicist perspective,
is always correct as the Efficient Market Theory predicts. Looking at bonds it becomes a less
ambivalent model, as the maturity value and the interest payments are known. Comparing the
present value (cash flow and maturity value in today’s money) to the current market value of
the bond. 141 The difference between the nominal value and market value depends solely on
135
G.D. Jud, D.T. Winkler, ‘the Q theory of housing investment,’ Journal of Real Estate Finance and Economics 27:3
(2003) 379-380; it needs to be noted that the neoclassical adjusted Tobin Q analysis is entirely oriented on the new house
buildings, not on existing housing.
136
See for example: M. Corder, N. Roberts, ‘Understanding dwellings investment,’
137
J.P. Fortuin, Stock Market Information Processing Model (Nijmegen 2007) 21
138
Ibid., 25-30
139
Fabozzi, F.J., F.P. Modigliani, F.J. Jones, Foundations of Financial Markets and Institutions, 180-186
140
G.D. Jud, D.T. Winkler, ‘the Q theory of housing investment,’ 380-381
141
Fabozzi, F.J., F.P. Modigliani, F.J. Jones, Foundations of Financial Markets and Institutions 374 & 377: ‘the price of
a bond is equal to the present value of its cash flow’
44
the difference in the interest rate. In other words, other market forces (like bubbles in asset
values) should not persist.
Housing market models

In the previous section I discussed several pricing models for the housing market. In this section I
will discuss several market models regarding the structure and inner workings of the housing market.
1. Housing Market Efficiency

This principle is directly related to the last model in the previous section, the Efficient Market
Theory. In the last decades, several researchers have tried to answer if the (American)
housing market does resemble an efficient market, in the definition of the Chicago based
professor Eugene Fama (developed around 1970). 142
Large transaction costs (typically around 6 percent of the purchase price), large carrying
costs, long lags between sale and actual transaction, and other similar items are considered to
be impediments to market efficiency. 143 But the actually mathematical testing to confirm the
housing market is inefficient, has been problematic and therefore also contentious.
The theory of Eugene Fama (Efficient Market Hypothesis) is important for testing for
efficient markets, so let us start with how Fama defines efficiency, which is related to
information. According to his theory, prices will fully and instantaneously incorporate all
relevant information. 144 The effect of this proposition is that short-term price deviations are
not forecastable, because nobody knows what kind of news comes next, so the price will
follow a so-called random walk, in mathematical terms better known as a martingale
process. 145
There are several methods of testing for efficiency, one is comparing prices versus the
discounted present values of the rents, but this method is not preferred because there are
problems with the relation between rents and the housing sales market. These problems are
the result of a lack of relation between both markets, because of different sorts of houses,
different kind of housing consumers, or the impact of government regulations. Secondly there
are widely used mathematical tests 146 pointing towards serial correlations in house prices and
142
F. Schindler, Further Evidence on the (In-)efficiency of the US housing market, ZEW working paper (2010) 4
143
E.R. Larsen, S. Weum, ‘Testing the efficiency of the Norwegian housing market,’ Journal of Urban Economics 64
(2008) 510
144
Ibid., 511
145
R. Rosenthal, Efficiency and Seasonality in the UK Housing Market, 1991-2001,’ Oxford Bulletin of Economics and
Statistcs 68:3 (2006) 290
146
M. Cho, ‘House Price Dynamics: A Survey of Theoretical and Empirical Issues,’ Journal of Housing Research 7:2
(1996) 145-167
45
that would mean in scientific terms, that prices could be forecasted with current information
and that is in contradiction with the definition of an efficient market. And thirdly tests based
on changes in real determinants, which clearly has problems as there is no consensus in the
economic profession what these real determinants are. 147
But looking at the most applied methods, the above mathematical tests, are not without
problems either. As Karl Case and Robert Shiller already made clear in 1989, housing prices
indexes consist of a lot of noise creating huge obstacles for this mathematical testing. 148
They, and many other researchers after them have adjusted house price indexes, created new
ones, and added other formulas to solve this problem, but still there is no definite conclusion,
let alone consensus. 149
A widely applied reasoning by researchers arguing in favour of an efficient housing market is
problematic as well. They argue that if the housing market is inefficient, there should be
information that is actually exploitable. 150 But the structure of the housing market, there is for
example no options market, denies easy exploitability of these profit opportunities. A stronger
argument against the reasoning by these proponents of efficient housing markets is in the way
they apply science. They use an argument from classical logic called “reductio ad absurdum”,
that implies that if you can prove that one view is not correct, than the other one must be true.
In my opinion these kind of problems cannot be translated into simple for or against
positions, it is far more complicated than that.
So where do we stand towards housing market efficiency, first I want to note that most testing
for market efficiency rejects the hypothesis that the housing market is efficient. 151
Furthermore the ones that posit that the housing market is efficient do so mostly on grounds
that the inefficiency is not proven, while they agree that testing for efficiency is difficult due
to the unavoidable noise in the housing data. 152 Thirdly, as I indicated at the beginning, there
are many structural characteristics of the housing market that point towards a high probability
147
E.R. Larsen, S. Weum, ‘Testing the efficiency of the Norwegian housing market,’ Journal of Urban Economics 64
(2008) 511
148
K.E. Case, R.J. Shiller, ‘The Efficiency of the Market for Singly-Family Homes,’ The American Economic Review
(1989) 126-136
149
See for example, among many others: J. Lewellen, S. Nagel, J. Shanken, ‘A Sceptical appraisal of asset pricing tests,’
Journal of Financial Economics 96 (2010) 175–194; K.E. Case, R.J. Shiller, ‘The Efficiency of the Market for Singly-
Family Homes,’; R. Rosenthal, Efficiency and Seasonality in the UK Housing Market, 1991-2001,’ Oxford Bulletin of
Economics and Statistics 68:3 (2006)
150
R. Rosenthal, Efficiency and Seasonality in the UK Housing Market, 1991-2001,’ 290-291
151
J. Rouwendal, S. Longhi, ‘The Effect of Consumers' Expectations in a Booming Housing Market,’ Housing Studies
23:2 (2008) 293; Rouwendal cites studies by Case&Shiller (1989), Hill (1999) and Englund (1999), all reject the efficient
market hypothesis; F. Schindler, ‘Further Evidence on the (In-) efficiency of the US housing market,’ ZEW Working
Paper (2010): A more recent research paper by ZEW also declares the American housing market as inefficient. Schindler
also cites research by Gu (2002) who also confirms the inefficiency of the US housing market.
152
R. Rosenthal, Efficiency and Seasonality in the UK Housing Market, 1991-2001,’ 290
46
that this market is an inefficient market. Finally, the efficient market hypothesis denies the
existence of bubbles, 153 while the housing markets as explored in the second part of this
thesis do show bubbles. So all things considered, my starting point will be that the housing
market is an inefficient market.
2. Imperfect markets: information asymmetries

Some research into the housing market points towards the existence of Information
Asymmetries (IA) 154. The role of IA has been primarily applied to the credit markets, where
J. Stiglitz and A. Weiss pointed towards better knowledge by the borrower about the
investment, than the lender, which means that lenders are risk-averse. In short, in Stiglitz’s
restricted banking world, banks are rationing credit, which means that the interest rate is not
an equilibrium rate. 155 Interestingly, the use of collateral has been promoted as a solution to
averting this risk (although Stiglitz’s restricted banking model has become far more complex
than his earlier system, only restricted by IA 156). The use of collateral to offset information
asymmetries has been promoted in several theoretical and empirical research reports. 157 One
of the problem of this research is that it depends on the correct calculated value of the
collateral, a feature that for property collateral might be more difficult than this branch of
research suggests (especially if the risk of default is correlated to the risk of asset
devaluation).
3. Imperfect markets: imperfect competition

Instead of focussing on information, other New Keynesians have focused on imperfect
competition. 158 Making firms price setters, instead of takers, makes an important difference to
the inner-workings of markets. This element highlights the procedure through which house
prices are reached. With price-negotiations it seems very competitive, but the role of real
estate agents and other third parties is essential in the outcome of these price-negotiations. If
real estate agents, instead of sellers, are considered to be the price setters, an entirely different
motivation (fees are normally based on the sale price) can influence the market.
153
E.R. Larsen, S. Weum, ‘Testing the efficiency of the Norwegian housing market,’ 511
154
T. Steijvers, W. Voordeckers, ‘Collateral and Credit Rationing: a review of recent empirical studies,’ Journal of
Economic Surveys 23:5 (2009) 925
155
J.E. Stiglitz, B. Greenwald, Towards a New Paradigm in Monetary Economics (Cambridge 2009) 295-296
156
J.E. Stiglitz, B. Greenwald, Towards a New Paradigm in Monetary Economics, 34-42
157
T. Steijvers, W. Voordeckers, ‘Collateral and Credit Rationing: a review of recent empirical studies,’ 925
158
N.G. Mankiw, R. Reis, ‘Imperfect Information and Aggregate Supply,’ Working Paper (2010) 35
47
4. Local network perspective 159

As economic pricing models often not represent actual prices, and also inspired by the new
research area of Behavioural economics, some researchers have taken a social networking
approach to the pricing system. Here all economic agents, sellers, buyers, estate agents,
surveyors, investors, mortgagers, researchers, and incidental others, all interact in a process
that eventually leads to a sale-price, which does not necessarily needs to reflect
“fundamental” values (quantitative calculations based on fundamentals were even influenced
by expectations of preferences from the other participants, “feeling the market” as some call
it). An important remark was that this process of social impact on the price setting process
increased when volatility increased (and the information value of past sales was considered to
be decreasing). This perspective also points towards a very unstable nature of the housing
market, where past prices are becoming less relevant with large volatility, which can bet
triggered by a short-term sudden increase of demand (for example of economic expectations
improve, or interest rates decline).
5. Behavioural markets
Especially Robert Shiller has been a proponent of the effects of people’s attitudes to housing
investment, or as he calls it “irrational exuberance”. The researchers point towards, for
example, the difference between the theory and the practice of valuing houses. 160 Others point
towards the psychological effect of higher prices, as people tend to appreciate a higher price,
as they argue it represents higher quality, even if fundamental factors argue otherwise. 161 On
the other hand, low pricing (asking price, not sale price) is known to be used to entice a
bidding war. 162
Behaviour has been an increasing element in analyzing the housing market, not the least
because of the stature of Robert Shiller. These researchers mostly point towards behaviour
based on non-price considerations. An example of such a non-price consideration, as noted by
Banks, is fear. 163 Banks describes a “fear of being excluded”. If price appreciation is
expected, people might get priced out of the housing market in the near future. They fear they
cannot pay for the house they want if they wait (due to price rises, while they wait), so they
159
M. Munro, S.J. Smith, ‘Calculated Affection? Charting the Complex Economy of Home Purchase,’ ; this entire
section (point 4) is based on this article.
160
Idem
161
One of my personal favourites was when Range Rover upped the price of their new car from 120.000,- to 150.000,-.
The reason given was that it was not due to higher quality or higher building costs, but due to the fact that some potential
buyers thought the ‘cheap’ price was susceptible in relation to pricier competitors and this kept them from buying the
previous model.
162
M. Munro, S.J. Smith, ‘Calculated Affection? Charting the Complex Economy of Home Purchase,’ 356
163
Ibid., 363
48
pay a premium now to secure the house. So the premium is less irrational than the more
general terms like ‘herd behaviour’ sometimes seem to entail.
2.3 the relation between macroeconomics (chapter three) and microeconomics (chapter two)
At the end of chapter one, I listed five points that I should focus on in this chapter, so lets review
these items:
1) The (in)efficiency of the housing market

As described in the previous section, based on earlier research, the housing market is
considered no to fit the description of an efficient market. A conclusion that I will use as an
assumption in the rest of this paper.
2) The structure of the housing market (frictions and rigidities)

The frictions can most easily be found in the above mentioned price setting mechanism of the
housing market. From a “rational” point of view the use of price comparisons for setting
housing prices (especially the short-term perspective) can sustain unfounded price rises. This
looks similar to momentum traders in bubble settings (see chapter three). Other frictions that
can lead to price distortions can be found in the complex nature of the network of economic
agents involved, which apparently can have its own dynamics. We have also seen that high
volatility disrupts the most used price setting mechanism, the comparison rule. Finally the
market asymmetries between different actors should be mentioned. Buyers are mostly not
aware of the pitfalls, while sellers are (they normally know the problems of their own house).
The advisors should correct this information asymmetry, but their knowledge as well as their
incentives (fee related to selling price or professional relationship with other involved third
parties), might direct them otherwise.
3) The price determination process

As discussed in this chapter the price determination process is influenced mostly by two
economic agents with two different attitudes. The real estate agents and surveyors base their
price setting on comparing to recent sales, but the buyers are strongly behavioural driven,
which in turn influences the real estate agents and surveyors. The final sale price therefore
does not have to be fundamentally based whatsoever, even if the asking price was. Buyers
themselves are furthermore influenced by their ability to borrow. As they tend to borrow as
much as possible, they might be willing to overpay for the house they want.
49
4) Behavioural aspects
As already mentioned with point three, especially with buyers, and then especially the owner-
occupiers (less so the professional investors) are behavioural driven. As mentioned in survey-
based research, a lot of remarks are made that buyers were “simply in love” with the house.
Also the short-term orientation of many of the involved advisors makes them have some
elements of “momentum traders”.
5) Micro/Macro
In the first section of this chapter we have seen that housing demand is driven by micro-
economic elements, with the complex structure of the market and behavioural aspects. Other
more macro-economic elements are influencing the housing market, but how and in which
way, is the result of these micro elements. For example interest might be important, but the
way the market reacts to interest rate changes is not necessarily related to “utility
optimization”. The influence of interest rate changes (higher affordability) might be little in
comparison to rising debt-to-income ratios, as buyers simply want to borrow as much as
possible, not necessarily in a financial efficient way.
50
Chapter 3: What about bubbles?
The previous two chapters were about analyzing the economy and housing market in mostly standard
settings. While an understanding of the workings of the economy in general (chapter one) and the
housing market (chapter two) is necessary, I will have to add the specific theories about bubbles into
the mix. Bubble theories are theories oriented to the nature of price deviations, the cycle of booms
and busts as experienced in many parts of the economy.
This chapter looks first into the general research of bubbles and thereafter translates this into
housing market bubbles. Most researchers analyzing bubbles see them as price-deviations from
fundamental values. 164 The bubbles described here are all related to asset bubbles. The definition for
bubbles used here will be presented in chapter four as part of the analyzing framework.
The research into bubbles has become somewhat of a battlefront between New Classicists
versus New Keynesians (and others like Post Keynesians, Behavioural Economists, etc). This might
be expected, as the area of interest (asset markets), brings academics and the business world together
into the same discussion topic. As already mentioned in my introduction, the academic world is
mostly populated by New Keynesians, while the business world is profoundly a supporter of the
Efficient Market Hypothesis and New Classicists. It is therefore no coincidence that I will discuss
theories about bubbles that are clearly based on either of the two main economic schools of thought.
3.1 Bubbles in economic theory

Bubbles seem to be a phenomenon of all ages, although events before the middle ages might be
difficult to interpret, due to the circumstantial evidence. 165 There are some very famous early
bubbles, most notably the Dutch Tulip Mania (1630s) and the South Sea Bubble (1719-1720). More
modern examples are the railway mania and the stock market bubble of the roaring twenties. Most
contemporary and historical reviews have stressed irrational behaviour (hence the use of words like
mania), although the New Classicists strongly oppose this view. 166
The research into bubbles has, for the biggest part of the past century, not been a prominent
research area in economics and a minor one in historical research (which was mostly focused on
bubbles before the 20th century). Bubbles has mostly been researched in the light of financial crises
164
M. Dufwenberg, T. Lindqvist, E. Moore, ‘Bubbles and Experience: An Experiment,’ The American Economic Review
95:5 (2005) 1731
165
E. Chancellor, Devil take the Hindmost. A History of Financial Speculation (London 1999) 6
166
P.H. Hendershott, R.J. Hendershott, C.R.W. Ward,, ‘Corporate Equity and Commercial Property Market Bubbles,’
Urban Studies 40:5 (2003) 993-994
51
(as the popping of a bubble generally results in a crisis 167) and as Charles Kindleberger
acknowledges the lack of a big crisis during the period 1945 until 1972 also dampened the interest in
the subject. But the crises of the 1970s and 1980s has revived the subject. 168 The stock market crash
of 1987 and especially the popping of the spectacular stock and land price bubbles in Japan at the
end of the 1980s has made bubble research a lively research field again.
Rational Bubbles
The idea of rational bubbles dates back to the Classicists. For example, Adam Smith dubbed the
South Sea Bubble, a rational bubble and many (New) Classicist concur with his view. 169 In principle
there is no room for bubbles in the Classicist economic theory. 170 But it was impossible to ignore the
strong price rises and subsequent collapses of the many famous bubbles, like the ones mentioned
above. So the Classicists developed the idea of rational bubbles, in which the price rises can be
explained with rational acting agents. In normal conditions the price of an asset should be equal to
the present discounted values of expected future cash flows. 171 This calculation can be seen as the
fundamental value of an asset. But future cash flows are difficult to predict and it is to be expected
that investors disagree about these future cash flows and therefore disagree about the fundamental
value. 172 If there is much doubt about the fundamental value, it is possible that investors are
generally to optimistic about future cash flows, which will drive up prices until investors realize that
the real fundamental value was lower than first thought, and prices crash. 173 Hence the explanation of
the rational bubble.
This idea has been mostly used in the analysis of stock market bubbles. As with many stock
market bubbles, an important element, at least in triggering the bubble, is an outsize believe in some
new investment possibility with larger than normal profits. The historian Larry Neal also labelled the
South Sea Bubble a rational bubble in his book published in 1996. 174 His argument was that, due to
some financial innovation, investors were prepared to pay a liquidity premium at first, and later
noticed the manipulation of the directors of the South Sea Company, and joined them in the
“rational” bubble (rational in the fact, that everybody knew it was a bubble) and it only came to an
end as the company was not able to meet its obligations anymore. The idea of a rational bubble, with
167
S.G. Cecchetti, ‘The Brave New World of Central Banking: Policy Challenges Posed by Asset Price Booms and
Busts,’ National Institute of Economic Review 196 (2006) 107
168
C.P. Kindleberger, Manias, Panics, and Crashes. A History of Financial Crises (New York 1989) 3-4
169
E. Chancellor, Devil take the Hindmost. A History of Financial Speculation (London 1999) 94-95
170
D. Abreu, M.K. Brunnermeier, ‘Bubbles and Crashes,’ Econometrica 71:1 (2003) 173
171
Urban Studies 40:5 (2003) 995
172
Idem
173
Ibid., 1007
174
E. Chancellor, Devil take the Hindmost. A History of Financial Speculation 93
52
the disagreement about fundamentals, seems to have merit. But the reality of the actual bubbles
paints a different picture. Take for example the South Sea Bubble, where The South Sea Company
derived its income directly from government annuities, so its underlying value could actually be
calculated with little room for error and has been put at £150,- (this was knowledge available at the
time). 175 The South Sea Stock peaked at £1,050! 176
Other explanations of a rational bubble, for example by Peter Garber, is that prices rising
above fundamental values can be explained by expectations of rising prices, either as a momentum
trader or noise trader (instead of fundamentals they use trends for trade decisions, but can still be
“rational” 177), or if he is expecting a rise in profitability. 178 The noise traders argument holds merit
as well, as these noise traders are not bounded by fundamentals, while trends, especially short to
medium term trends, can disguise the forming of a bubble. 179 These so-called noise traders appear
similar to current stock market traders or technical analysts, who use trend analyses and portfolio
management with efficient market based models (oriented towards differences in return, not analysis
of fundamentals, seem to be an actual example of these noise traders 180). To classify these noise
traders as rational might stretch the definition. One important element of the Classicists model is that
economic agents make optimal use of all information. Trend traders, mostly ignore warnings of a
subsequent crash and only a few can get out before the crash. So the “rationality” of these agents and
their actions might be in contradiction with the wider Classicists assumptions. A good example of
this lack of fundamentals was eToys.com, a company that, as the name suggest, sold toys only
online. In 1999 its turnover was 30 million dollars, and the company made a loss of almost 29
million dollars the same year. 181 But it was valued at the NASDAQ for 8 billion dollars, some 2
billion dollars more than Toys ‘R’ Us, a toy company with actual stores and a website, a turnover of
11 billion dollars and a profit of 376 million dollars. 182 Still, New Classicists argue that the dot.com
bubble was based on rational assessments of future cash flows. 183
Credit & Asset cycles

During the 19th century booms and busts were very apparent and much researched. The bust
depressed asset prices and made them a bargain and that led to investors seeking profit resulting in
175
Idem
176
Ibid., 83
177
M. Youssefmir, B.A. Huberman, T. Hogg, ‘Bubbles and Market Crashes,’ Computational Economics 12 (1998) 98
178
E. Chancellor, Devil take the Hindmost. A History of Financial Speculation (London 1999) 94
179
M. Youssefmir, B.A. Huberman, T. Hogg, ‘Bubbles and Market Crashes,’ 98
180
Idem
181
R.J. Shiller, Irrational Exuberance, 181
182
R.J. Shiller, Irrational exuberance, 181
183
1001
53
rising asset prices and the consequence was more supply of credit (as higher asset prices could
support more credit). The rising asset prices and easier supply of credit was the ideal setting for
speculators, which led to the actual bubble, until a shock of any kind could result in a crash. Several
economists during the 19th century have addressed this cycle (for example, John Stuart Mill and
Walter Bagehot 184), but it is also close to the Financial Instability Hypothesis of Hyman Minsky, as
at the peak of the cycle can be called a credit cycle. Many speculative investments are supported by a
Ponzi scheme situation (only rising asset prices would make the investment profitable) and Hyman
Minsky’s theory is a description of a boom-bust cycle. Analyzing the aftermath of crashes the
unsustainable high levels of debt-to-value ratio’s (i.e. Ponzi schemes) do seem to be an important
element in the severity of the crash. This analysis is very critical of speculation and its supposed
positive liquidity effect. This positive liquidity effect is due to speculators who make markets liquid
and correct over- and undershooting of actual prices versus fundamentals (which are profitable
moments), resulting in more stable markets, at least according to theory.
The Financial Instability Hypothesis of Hyman Minsky is especially favourite with Charles
Kindleberger, one of the main researchers of bubbles. 185 Although Charles Kindleberger also states
that behavioural effects are also an important explanation. 186 Based on Charles Kindleberger’s
assessment of behavioural factors and credit cycles, researchers has sought for reasons why banks
have an anti-cyclical view of risk (lower risk assessments during upswings and higher risk
assessments during downswings). This might be due to the structure and competitiveness of the
banking system. An upswing entails a growing credit market and banks are in a race to hold on to
their market share, which leads them to take on more risk than in more stable situations. The reason
given is behavioural. Due to bounded rationality people are more critical during downturns and only
accept strong mathematical assessments for investment decisions, while during upswings people are
content with “simple” calculations. 187
New Economy bubbles

This kind of bubble is one that has been analyzed many times, but apparently the memory of
investors is short, as the underlying assumptions keep popping up time and again. The basis of these
bubbles is the essence of our modern society, namely innovation. New sectors arise with uncertain
profitability. The expected profitability from companies within these new sectors can be very
184
E. Chancellor, Devil take the Hindmost, 120,121
185
P. Barns, ‘Minskys financial instability hypothesis information asymmetry and accounting information: the UK
financial crises of 1866 and 1987,’ Accounting History 12:1 (2007) 30
186
T. Lux, ‘Herd Behaviour, Bubbles and Crashes,’ The Economic Journal 105:431 (1995) 881-882
187
T.F. Rotheli, ‘Causes of the financial crisis: risk misperception, policy mistakes and banks’ bounded rationality,’
Journal of Socio-Economics (2010) 5
54
favourable, while there is no past experience to use for comparison. In theory the possible
profitability can be very high. Sometimes the companies that enter this market at a relatively early
moment do generate exceptional profit margins, which do seem to support these expectations. But
these high margins normally are eroded by rising competition as new entrants swamp the new sector
in search for these same margins. Examples of these kind of bubbles are the canal-mania (1790s), the
railway-mania (1840s), and of course the dot.com bubble at the century’s turn to the 21st century.
The bubbles mostly start based on these expectations of high profitability in these sectors, but in the
last part of the bubble it mostly looks like the above described asset/credit bubbles, as speculators,
fuelled by debt, push share prices even higher.
Another, but related bubble, is about a belief in “new economic systems”, not unlike the
phrase “this time is different” (this phrase is used as a sarcastic title of the new book by K. Rogoff
and C. Reinhart). 188 The 1920s economic growth led to a believe that an era of unknown prosperity
had arrived, in which old principles were not longer relevant, which ended in a bubble on Wall Street
and subsequent crash (although the reason for the crash and the Great Depression have more to do
with monetary policy and fiscal policy after the crash). 189 The same kind of “new economy fallacy’
was apparent during the 1980s, especially in Japan, which was “sure” to overtake the US economy
and a stock market and housing market bubble were at least a by-product. 190 The latest “new
economy” fallacy came with the dot.com bubble. Even according to Federal Reserve Governor Alan
Greenspan, this time was actually different. Sadly, the debt fuelled bubble and crash in 2001 proved
otherwise (interestingly, there was no Great Depression or Lost Decade that followed, although some
“blame” this on the creation of a new bubble, the housing bubble, to correct the losses of the popping
of the dot.com bubble). 191
Intrinsic Bubbles
Kenneth Froot and Maurice Obstfeld devised an intrinsic rational bubble model to explain excessive
price deviations from standard present-value models. Instead of exogenous explanations, they based
the fluctuations on changes in fundamentals (hence intrinsic bubbles), but due to behavioural effects
over- and undershooting of prices occurs. 192 Kenneth Froot and Maurice Obstfled developed the
theory as most research confirmed the long-run relationship between earnings and stock prices, but
changes in earnings (or dividends) failed to explain changes in stock prices. So they developed a
188
C.M. Reinhart, K.S. Rogoff, This Time is Different. Eight Centuries of Financial Folly (New Jersey 2009)
189
R.J. Shiller, Irrational Exuberance (revised second edition; New York 2005) 112-115
190
E. Chancellor, Devil take the Hindmost, 310-322
191
R.J. Shiller, Irrational Exuberance, 118-120
192
L.F. Ackert, W.C. Hunter, ‘Intrinsic Bubbles: The Case of Stock Prices,’ (1999) 1372
55
non-linear model for market reactions to these changes in earnings or dividends. 193 In the article
researchers dismiss standard rational bubbles, but they also had trouble to adjust their model to fully
explain price-deviations. 194 Although their article is called intrinsic bubbles, all Classicists (also the
proponents of rational bubbles) dismiss these theoretic constructions as true bubbles, because in the
end they try to offer a rational explanation for the price-deviations (in short the price is always
correct). 195 The remark by Kenneth Froot and Maurice Obstfeld at the end of their article is therefore
telling of their struggle as they state that “Perhaps the results above merely show that there is a
coherent case to be made for bubbles alongside these alternative possibilities. If that is so, then we
should not feel too comfortable about how well we really understand stock prices”. 196 Research into
intrinsic bubbles has continued and although the relationship between earnings and stock prices in
general have a strong relationship, this relationship breaks down in periods that have been identified
as bubble periods and during this bubble periods, the intrinsic bubble model still fails to account for
the stock price deviations. 197
Bubbles in imperfect markets

Instead of some kind of irrationality, these ideas about bubbles are more structural oriented. The
structure of, for example, the financial market and its pro-cyclical behaviour can result in an
oversupply or undersupply of credit during GDP growth and recessionary periods (i.e. the wrong
reaction at the wrong moment in time). The housing market is also not a market known for its perfect
competition. With reference to chapter two, the fluid price setting mechanism of the local networks
perspective suggest that advisors can have an adverse affect, but that even higher volatility might
disrupt the price setting mechanism. Combined with sufficient capital, this market imperfection can
result in price distortion that can result in bubble creation.
Bubbles and behavioural economics

Most researchers (especially New Classicists) have problems with irrational bubbles, as it implies
some irrationality with economic agents (they do not dismiss irrational traders per se, but that these
“loners” are overwhelmed by arbitrageurs who correct this on an aggregate level 198). They argue that
it is simplistic and not useful to consider temporary stupidity with economic agents for explaining
193
K.A. Froot, M. Obstfeld, ‘Intrinsic Bubbles: The Case of Stock Prices,’ The American Economic Review 81:5 (1991)
1191
194
Ibid., 1190 & 1209
195
Ibid.,1190
196
Ibid, 1209
197
A.S. Chen, L.Y. Cheng, K.F. Cheng, ‘Intrinsic bubbles and Granger causality in the S&P 500: Evidence from long-
term data,’ Journal of Banking & Finance 33 (2009) 2275–2281
198
D. Abreu, M.K. Brunnermeier, ‘Bubbles and Crashes,’ Econometrica 71:1 (2003)173
56
bubbles. 199 But this judgement is in itself a too simplistic assessment of behavioural analysis. Based
on psychology, test analysis, and other scientifical based research, evidence does point to explainable
behaviour, that does not fit our description of rational behaviour. 200 This does not imply stupidity,
but emotional influences can lead to different reactions than simple mathematical calculations,
maybe if we led robots do our investment, it may lead to less erratic behaviour. Behavioural
economics has found several effects that can lead to behaviour that is in conflict with our standard
rational assumptions and therefore might fuel bubbles.
Dilip Abreu and Markus Brunnermeier have reacted to the critique that rational arbitrageurs
will correct irrational or behavioural investors. These rational arbitrageurs acknowledge the
overvaluation, but in rising markets, how irrational it might be, money can be made. So these
arbitrageurs, instead of constant correcting behaviour, try to figure out the exit strategy, while
enjoying profits from the rising prices. 201 The bubble pops when enough arbitrageurs decide to step
out. Their theory is a beautiful construction of herd behaviour with professional and rational
investors. This model also makes comparisons and relative prices of almost exact assets more
important than fundamentals during booms (i.e. momentum traders). To my opinion Dilip Abreu and
Markus Brunnermeier make an interesting case by taking the notion that the representative agent, as
Classicists argue, does not exist and that the population is heterogeneous in behaviour. The problem
for residential housing markets is the lack of sufficient rational and/or professional arbitrageurs.
Another behavioural element that has seen many proponents (including Charles
Kindleberger) is herd behaviour. This concept is based on “opinion contagion”, where (normally
non-sophisticated) speculative traders mimic others (who might be just as uninformed as they are as
non-sophisticated traders). 202 The strong side of this argument, is that it works both ways, either in a
bull market, or in a bear market. It also fits the above remarks of Abreu and Brunnermeier.
One of the earliest critiques of rationality, was Simon’s bounded rationality. Bounded
rationality argues that economic agents are bounded, or limited in how they retrieve, store and use
information. They have already formed a certain set of expectations and they only take that
information to themselves, which corresponds to their expectations, but ignore other information.
They also do not strive to have the best information, but settle for “good enough” information. The
information they need is also not readily available like in a menu, but they have to search for it,
199
200
T.F. Rothelli, ‘Elements of behavioural monetary economics,’ edited M. Altman, Handbook of contemporary
behavioural economics. Foundations and Developments (London 2006) 689-704
201
D. Abreu, M.K. Brunnermeier, ‘Bubbles and Crashes,’ 174
202
T. Lux, ‘Herd Behaviour, Bubbles and Crashes,’ 882
57
which limits the impact of information. 203 Bounded rationality, as already discussed above (see
above: intrinsic bubbles), is normally associated with over-optimism and over-pessimism.
Although in line with the above mentioned points, I want to add one more, namely that
changing thought patterns are the main cause of economic crises. This proposition is done by Akerlof
(won a Nobel Prize for his behavioural economics in 2001) and Robert Shiller in their book Animal
Spirits (2009), which is a remark of Keynes’s animal spirits. They also accept some sort of
overshooting in markets based on over- and under-confidence by economic agents affected by
confidence, corruption, money illusion and storytelling. 204 Robert Shiller in his book “irrational
exuberance” labels these reinforcing behavioural elements as a “positive feedback loop”. 205
3.2 Housing Market Bubbles

Most research into asset bubbles is related to stock market bubbles, which can be different from
housing market bubbles, as the working of the market and the role of economic agents in these
markets are entirely different. In this section I will review bubbles in a housing market setting.
Although not all researchers are always as specific, there are differences in the property market in
which to analyse bubbles. First there is a commercial property market and there is also a residential
property market. Secondly there is market for new buildings and there is a market for existing
buildings and all of these markets might react differently. I will focus on the existing (residential)
property markets, as these are much larger in size than the new building markets.
Rational Housing Bubbles

Rational housing bubbles can result from disagreements of fundamentals, although research has
shown that deviations of actual house prices versus different kinds of fundamentals are long lasting
and sometimes even almost pertinent. 206 Trend traders or momentum traders might also be
interesting, although the difficulty is the lack of professional traders/investors in the primary housing
market. To have these kind of arguments working, there must be a direct link between primary
mortgage markets and the secondary mortgage markets. Secondary mortgage markets are dominated
by professional traders, but the interaction with primary markets might result in a bubble in the
housing market that stimulates a bubble in secondary markets (as asset prices rise), while this fuels
the credit availability of the primary market, which in turn might fuel the bubble in the housing
203
F. Collet, ‘Does Habitus Matter: A Comparative Review of Bourdieu's Habitus and Simon's Bounded Rationality with
Some Implications for Economic Sociology,’ Sociological Theory 27:4 (2009) 422
204
H. Schwartz, ‘Does Akerlof and Shillers Animal Spirits provide a helpful new approach for macroeconomics,’ The
Journal of Socio-Economics 39 (2010) 153
205
206
C. Hott, P. Monin, ‘Fundamental Real Estate Prices: An Empirical Estimation with International Data,’ Journal of
Real Estate, Finance and Economics 36 (2008) 427-450
58
market. This creates room for momentum traders in the secondary mortgage market in extending the
original bubble. Research in the securities market has been done, but I am not aware of any research
that has been made of the above described interactive link between the two markets.
The argument made by Hendershott regarding commercial real estate is the major uncertainty
about fundamental values. The existence of doubt about fundamentals combined with sudden rent
rises in commercial real estate during booms, creates room for overshooting due to overoptimistic
investors that these rent rises are sustainable in the long run. 207 He cites evidence of the London and
Sydney commercial real estate with strong rent rises in the early 1980s before collapsing in the late
1980s. The problem with Hendershott’s argument is that the property market is not an efficient
market. He himself cites the excessive transaction costs, 208 which is in contradiction with the
Efficient Market Hypothesis, and therefore the market model he based his argument on is not
existent in the actual property market.
Behavioural ‘Minsky’ Housing Bubbles

The theory of Financial Instability Hypothesis (FIH) can be adjusted to the housing market with
some insights of New Keynesian research. If we accept that house buyers, either as investors or
owner-occupants, are not necessarily (only) interested in the optimal financing construct of the deal,
but “simply” want a certain property, the financial system can have a major impact on the housing
market. Such investors do not search for a house and then such for their optimal financing structure,
but borrow as much as they can and then try to find the house that exemplifies their wishes the best.
So there are most of the time no rational decisions and therefore there is no perfect market. This
means that the only constraint is the availability of housing and the availability of credit. The
availability of housing is relatively fixed, as the number of new houses is rather small in relation to
existing housing.
If we look at circumstances with a declining risk assessment, or declining interest level, the
availability of credit rises, which causes rising demand for houses. As the supply is almost fixed,
rising demand will most probably result in rising prices. Rising asset prices result in even higher
supply of credit as the risk assessment is lowered by financial institutions. A Minsky Moment, or a
reversal in sentiment, will reverse the availability of credit and a subsequent drop in demand for
housing. As demand drops, the prices will drop as well, which will be exacerbated by forced sellers
with very high debt-to-value levels.
207
1003-1005
208
Idem
59
Robert Shiller and Charles Kindleberger take similar views of bubbles with an increasingly
fragile financial system combined with behavioural elements that not only support bubble forming,
but the change of confidence are also the main sources of trend reversals (i.e. crashes or flattening
out of growth trends), Shiller loosely defines this under the banner “feedback loop”. 209 Charles
Kindleberger nuances his support for Hyman Minsky’s theory, as Hyman Minsky argues for an
inherently unstable system, which should have resulted in far more bubbles and crashes than in
reality has been experienced. 210
Credit & Asset cycles in the housing market

This analysis argues that the seed for a boom are sown during the previous debt-deflation period (i.e.
the previous crash or downturn). At the bottom of the downturn, due to overshooting from a debt-
deflation effect, the assets are undervalued. This situation attracts investors, which leads to rising
asset prices. Rising asset prices in turn lead to higher credit availability (debt-to-value ratios
increase) and this fuels the upward swing until asset prices stop rising, and a downward swing of
debt-deflation is started. The debt-deflation is the result of lower asset prices leading to less credit
availability, which pushes asset prices further downwards, until asset prices are considered
undervalued again. The biggest problem of the cycle theory is that the turning points are not
supported by any kind of specifics, other than stochastic shocks. Also the cycle is very much alike
Hyman Minsky’s analysis and that one is probably more useful.
Behavioural dominated Bubbles

The housing market, as discussed in Chapter 2, does not seem to be driven by purely financial
considerations of utility maximizing economic agents. On the contrary, the housing market seems to
be driven by non-financial behaviour of non-sophisticated buyers and sellers. So instead of having
economic parameters being defined by behaviour, it might be possible to have herd behaviour, based
on mimic contagion, by people with bounded rationality driving the entire cycle. In that case
fundamentals, as well as long-term price-trends might be simply not applicable, as the markets
themselves disregard these elements. In that case demographic and income elements might only
create upper and lower bounds of house prices, while the market and prices are entirely driven by
herd behaviour and have no link with fundamentals. This assessment probably takes it too far, but
during my empirical analysis I will take this essentially short-term adaptive mimicking behaviour
into account. This means that based on turning points driven by the demographic and income
209
210
C.P. Kindleberger, Manias, Panics, and Crashes. A History of Financial Crises (New York 1989) 17
60
elements, people experience a turn in sentiment that leads to either a upswing or downturn, which is
sustained by a kind of path dependency defined by herd behaviour.
3.3 Bubbles here, bubbles there, bubbles everywhere?

Proponents of Classicist economics argue that bubbles are the result of wrong assessments about
uncertain future cash flows, or in other words bubbles exist because investors have a too optimistic
view about the fundamentals. This line of reasoning has been extended with momentum or noise
traders, who speculate on price rises based on short-term trend analysis. The remark about
fundamentals is interesting, but seems to fail in explaining the excesses that typify bubbles, although
this line of reasoning is capable of explaining booms and busts. The momentum and noise trader
argument is a very compelling argument, but it is difficult to understand how this idea fits into the
Classicist theoretic framework, as these traders should ignore fundamental accounts, even if they are
obvious.
The New Keynesians, Post Keynesians and especially Behavioural economists argument does
not agree that markets and market participants act rationally under bubble conditions. A combination
of behavioural aspects, like herding, positive feedback and money illusion, with the pro-cyclical
behaviour of credit is capable of explaining the excesses of bubble periods. Their problem of
reasoning is mostly with the rarity of bubbles. But here the biggest difference between the schools of
thoughts becomes apparent. As Charles Kindleberger acknowledges, his Minsky-behavioural model
for bubbles may “not be valid in all times and all places, but simply that there may be occasions
when it helps economists to understand what is taking place”. 211
Turning to the main elements regarding bubbles, it has become clear that these are the main elements
of this phenomenon:
1) Asset prices are based on fundamentals, which can best be stated as the discounted value of
the expected future cash flow (although future income is also used to include non-cash
elements). The more ambiguity about fundamental values the more a specific asset market is
prone to bubble creation.
2) There is a link with the financial system in the sense of credit availability, which in turn is
influenced by risk assessments, interest levels, debt-to-value levels, etc. These assessments
point towards the pro-cyclicality of credit, as supported by non-bubble research like that of
Ben Bernanke and Hyman Minsky. It needs to be noted that it is not only the availability of
211
C.P. Kindleberger, Manias, Panics, and Crashes. A History of Financial Crises (New York 1989) 247
61
credit, but the link between credit and asset values, as higher asset values lead to higher credit
availability.
3) The role of behaviour goes beyond any kind of rational expectations of utility maximizing
economic agents. According to almost all research regarding bubbles “animal spirits” of some
kind are responsible for fuelling bubbles. Note that even “rational” explanations like intrinsic
bubbles, resort to behavioural aspects, which can be used to explain deviations from
fundamental-based valuations.
62
Chapter Four: A Framework for Analyzing the Housing Market
In the previous chapters I have first discussed the relevant economic schools of thought. This offered
a broad overview about the ideas how markets in general work according to economists. The second
chapter delved into the housing market itself, with a descriptive analysis of the processes and
different theoretical descriptions of the housing market and housing prices. In the third chapter I
introduced some thoughts about bubbles in general and some thoughts about bubbles in the housing
market.
This chapter will incorporate these theories into an analyzing framework to be used in the
empirical second part of this thesis. With reference to the macro-economic discussion in chapter one,
the analyzing framework reflects my standpoint within this debate. So I would like to remind the
reader that my assumptions are based on New Keynesian insights of imperfect markets with
information asymmetries, economic agents influencing prices (instead of mere price takers), an
important role for credit, behavioural impacts, as the main influences. I will express the reasons
behind the choices I make in my analyzing framework, which will be important to understand the
conclusions derived from the results found within the data.
This chapter starts with the method to identify a bubble, which will be part of the method to
identify the boom-bust cycle within the housing market. This method will result in identifying three
periods, namely booms, busts and flat periods. The bubbles will be incorporated in the boom period
analysis, as bubbles can be perceived as extended booms. The second step in the analysis framework
will be a long-term analysis. This will consist of reviewing the housing market from six different
perspectives, like GDP and demographics. This analysis will be completed with a short overview of
the structure of both American and Dutch housing markets with a focus on the main regulations and
specifics. The third element of the analysis will zoom into the three identified periods (booms, busts
and flat periods). For this analysis I will present a specific viewpoint (the ability to borrow), which
setup will be explained in this chapter. This chapter ends with summarizing the main elements and
consequences of my chosen framework.
4.1 The boom bust cycle and how to identify a bubble

Although many researchers have discussed the appearance of bubbles, the exact identification of one
is far more ambiguous. Some researchers suggest the only way to identify a bubble is by its crash.212
That implies that bubbles always collapse. Furthermore it does not really solve the problem as you
212
For example Charles P. Kindleberger (2000) as cited in: P.H. Hendershott, R.J. Hendershott, C.R.W. Ward,
‘Corporate Equity and Commercial Property Market Bubbles,’ Urban Studies 40:5 (2003) 993
63
first need to identify the crash from the “normal” downturn. Instead of identifying bubbles by its
crash, I will start with simply identifying booms and downturns. The episodes of booms are of course
no bubbles in any definition, but I think it is an useful starting point, as a bubble can be considered to
be a too far expanded boom. Analyzing boom periods and not only bubbles might also shed some
light why some boom periods did not become bubbles.
Identifying booms and busts can be done in different ways, for example by analyzing actual
prices versus fundamentals. As discussed in chapter three and will become clear in chapter five, the
relation between fundamentals and actual prices in the housing market is not consistent enough to be
useful for the identification of booms, as it is for bubbles.
The other method often used is based on trend-analysis of the actual prices. Although this
way of analyzing is not able to discern bubbles, as higher average growth might be explained by
similar growth in fundamentals. But this method is able to simply splitting up the actual price
deviations into booms, busts and flat periods. Trend analysis can be done in many different ways,
from very simplistic to highly sophisticated (some technical analysts of stock markets use complex
mathematical techniques to analyse stock market movements and make predictions).
The simplest method is based on a change in the growth figure of housing prices from
positive to negative. With this method you identify a boom as a positive growth figure and a bust as a
negative growth figure. The problem with this method is that such absolute changes can be volatile
and we might therefore overlook obvious trends. I discard this method as too simplistic.
Another way is looking for changes in the growth figures themselves, in short we start
looking for trend breaks. This method is used by the Bank of International Settlements for defining
boom periods (8 consecutive quarters of rising growth figures, cumulative at least 19 percent growth
in prices, is considered to be a boom period). 213 The method works good when there is a smooth
trend, but, as with the simple method above, the analysis becomes a bit unclear when the trend in
growth figures is unstable.
A third way to look for these periods, is to compare the growth figures with the overall
average growth trend. In this last way we see the long-term average growth figure as somewhat of a
fundamental parameter and the swings around the trend signals the booms and busts. This is the most
widely used method and is for example being used by the Dutch Central Planning Bureau (CPB),
albeit incorporated in a far more complex model. 214
213
T.F. Helbling, ‘Housing price bubbles – a tale based on housing prices booms and busts,’ BIS Papers (2005) 32
214
J. Verbruggen, H. Kranendonk, M. van Leuvensteijn, M. Toet, ‘Welke factoren bepalen de ontwikkeling van de
huizenprijs in Nederland?,’ CPB Working Paper (2005) 10
64
I will use the third method together with the second method for extra reference. For the
identification of the specific periods I have smoothened the house price indexes to eliminate any
short-term noise. So I used a five-monthly moving average for the identification of the trend changes.
One last remark why I do not use more complex identification methods. First of all, I am not
qualified to create, test (especially testing for mathematical soundness is rather difficult) and apply
complex mathematical models. Secondly, most of these models are not only to be used to identify
booms and busts, but more to predict future changes. As I will not analyse through a model, but by a
broader and subdivided framework, the more simple trend analysis will be sufficient.
4.2 Long term trends and fundamentals

Before I can start with an in-depth analysis of the specific periods themselves, a long-term analysis
needs to be presented. This analysis will try to determine long-term driving forces of the housing
market and its fundamentals. This long-term analysis will show which elements are the essential
factors, but it will also show what effect fundamentals actually have on the housing price deviations.
The analysis has been subdivided in six specific perspectives, which are derived from the
previous chapters, mostly from chapter two. These six perspectives are not necessarily considered
fundamentals, but are at least perceived to be elementary to the housing market. For each of these
parameters the correlation with the housing prices will be calculated to find out if there is a
relationship between the two. A strong correlation is considered to be at least above 0.50, but I will
consider a correlation to be strong if it results in a figure above 0.75. 215 One remark, already often
made, is that correlations say nothing about causation. There are some mathematical tests for
causation (like the Granger causation test), but presenting a consistent theoretical structure of the
housing market, of which causation can be derived, will be used in this paper.
Hereafter the six perspectives will be introduced, with a short description of the parameters and an
explanation of the relationship with the housing market (and prices).
First I will analyse the relationship between three macroeconomic indicators and the housing
prices, namely Gross Domestic Product (GDP), inflation and unemployment. As already indicated in
the introduction there is a strong relationship between GDP and housing prices, but the causation is
for an important part from the housing market into the GDP figures. The relation between inflation
215
K.H. Jarausch, K.A. Hardy, Quantitative Methods for Historians: A Guide to Research, Data and Statistics (London
1991) 82; According to the literature the classification of the results into strong and weak correlations depends on the
expected values and the results themselves in comparisons to each other. Most of the results found in this paper are either
above 0.75 or below 0.35. Therefore I will classify a correlation as follows: between 0 and 0.1 = no relation; 0.1 – 0.4
weak relation; 0.4 – 0.75 moderate relation; 0.75 – 0.9 = strong relation; 0.9 – 1 = very strong relation. Final note: A
correlation result of one or negative one, indicates an identical movement of the two figures, a correlation result of zero
indicates that there is no co-movement (i.e. no relationship) between the two datasets at all.
65
and housing prices is a difficult one. Some suggest that housing is an inflation-proof investment like
gold, which means that high inflation will result in a flight from cash into housing, gold and other
inflation-proof investments. 216 Behavioural economists on the other hand point towards the
perception of many ordinary people, that low inflation means good economic conditions, which will
result in heightened demand for housing. 217 Finally, with reference to chapter two and the local-
network-perspective, high price volatility (normally also high inflation figures) can result in a
disruption in the price setting mechanism. Last, but not least, the unemployment figures influence
aggregate demand as more unemployed result in less people being able to buy a house. But the
psychological effect will probably be greater as people will fear for their job and postpone expensive
purchases (a so-called buyers strike), 218 while at the same time recently unemployed might be forced
to sell their house at fire-sale prices, forcing prices down.
The second set of parameters will look at the relation of housing prices to income and credit.
Income is generally considered to be one of the main fundamental parameters of the housing market,
as it is essentially the primary source of financing a house. But houses are normally worth many
times a person’s gross income, so the buyer will have to borrow the major part of the price of a house
(the buyer monetizes his future income). As made clear in chapter two, buyers tend to borrow as
much as possible, but how much is actually possible? To analyse the extend of borrowing the
parameter of leverage will be introduced, which sadly enough is not a parameter gathered by public
authorities or published to the public by private authorities. Some simply calculate the mean housing
prices versus the mean income level, but this will not be very useful in a comparison to the same
housing prices and I will not identify the role of credit. So, I have taken gross nominal mortgage debt
(which is published) and divided it by the number of houses to get an average of mortgage per house.
The figure is of course distorted by houses with bigger mortgages, but this distortion will not be that
relevant. 219 This because the next step, where, the average mortgage per house will be divided by the
mean nominal income to get an indication of the leverage level. But for my calculation, I am not
interest in this statistical distorted level, but in its changes, which will be far closer to the actual
changes in leverage than just the aggregate level-figure. The leverage index will indicate the role of
credit on the housing market.
216
T. Oatley, ‘Central bank independence and inflation: Corporatism, partisanship, and alternative indices of central bank
independence,’ Public Choice 98 (1999) 400
217
S.E.G. Lea, ‘How to do as well as you can,’ edited M. Altman, Handbook of contemporary behavioural economics.
Foundations and Developments (London 2006) 290
218
D.W. Diamond, R.G. Rajan, ‘Fear of Fire Sales and the Credit Freeze,’ NBER Working Paper (2009) 1
219
Furthermore, for the United States I have found average mortgage figure as published by the Federal Housing Finance
Agency (these are guaranteed standardized loans, not subprime loans and other low-document loans). These figures give
the trend in average supplied mortgage amounts over a long time period. Even if these are not the most extreme forms of
leverage (due to strict regulation), they follow my own calculation of leverage. Therefore I consider the leverage index a
good indication of the true overall leverage figure.
66
The third set of parameters is an assessment of the housing stock versus the number of
households. As explained in chapter two these two parameters should be somewhat equal, with
housing stock preferably a bit larger to smoothen the mechanism of supply and demand. Also
changes in demographics might have affected the housing market, by an oversupply or undersupply
of housing and will therefore be analysed. An undersupply of housing will have more people bidding
for a too low number of houses, which will probably have an upward pressure on housing prices.
This effect is of course limited, as people can only pay a certain amount for a house, related to their
income and borrowing capacity, so undersupply will not have an unlimited effect on the housing
market. Oversupply can have, in potential, a stronger effect on housing prices as forced sellers might
have to lower their prices further down in order to attract buyers than would be the case in a tighter
market.
Turning to the fourth set of parameters, I will look at one of the main fundamentals, namely
building costs. In theory a house (without the land!) should not be worth more than the rebuilding
cost of the house. If the valuation rises, this might be due to rare historic features, but might also be
due to higher land prices. The problem with valuations is of course the value of the land, which has
no fundamentals to refer to. One possible reference might be economic growth. Places with high
revenue per square meter (i.e. cities) are more valuable than places with low revenue per square
meter (for example some old deserted villages in rural France). Other features that make land
valuable are local conditions, like high paying jobs, but the sort of houses and infrastructure depends
on the sort of demand. Young Urban Professionals (or yuppies), will have other preferences than
families with two working parents. Instead of problems valuing a house, the biggest ambiguity might
be in land valuations. This is complicated by the fact that land values are almost nowhere available,
and if they are available, the prices are not transparent due to land and building combinations (the
value of the land might be higher or lower due to corrections on the building value). There has been
some research done into land prices (but related to land in and surrounding cities, namely Boston and
Chicago and oriented to older periods than in this research) that found strong price rises, but from
very low levels (and insignificant to the values of the buildings). The concluding remarks did point
to the economic growth effect on these land valuations, but also to the insignificance of the price of
land in relation to the overall housing price. 220
Anyone who has ever applied for a mortgage knows the importance of the interest rate.
Interest, not repayment, is normally the major part in the periodical cash payments to the lender. So a
lower interest rates makes houses more affordable. This assessment is also behind the condemnation
of the Federal Reserve for keeping the interest rates too low, for too long, after the dot.com crash and
220
67
thereby fuelling the housing bubble. 221 It is important to note that the interest rate the central bank
influences directly is the short-term interest rate, while mortgages are normally based on the far less
volatile long-term interest rates. The expected effect of interest rates, will be that lower interest rates
will drive up housing prices, and higher interest rates will bring them down. It will be particularly
interesting to see how much impact these interest rate changes actually have.
The final and sixth part of the long term analysis brings us to another much often cited
fundamental of housing prices, namely rents. The rent an investor receives for his property is the best
profit indication available for the capital investment of a house. That this is less straightforward than
expected at first glance might be expected as rents are not universally used in house price analysis.
The first problem for residential housing is that the link between the rental market and the housing
sale market is not that clear cut. Residential housing is mostly a sale market and the smaller rental
market is also often oriented towards specific parts of housing, like low-income housing, elderly
complexes (where rents include specific services) and so on. Furthermore the rental market itself
might not be considered to be an efficient market itself, so its prices might be the outcome of specific
rental market structure that have no relation whatsoever to the sale market (for example government
caps on rent levels). Also preferences for owning a house might under price the rental market. These
preferences can be the result of specific market structures. The Australian tenant for example is not
protected as good as in the Netherlands (a foreclosure by the bank of the landlord can result in a
short-term eviction of the tenant, an impossible feat in the Netherlands). 222 Still, rent might be useful
to get an perspective of the fundamental value of housing.
Beside the analysis of the driving forces of house price deviations, an analysis of
fundamentals will be used to identify which boom actually turned into a bubble. This is of course
based on the conclusion of chapter three, that a bubble can be seen as a deviation from fundamental
values. The existence of bubbles will be discussed in the latest section of chapter five based on the
fundamental analysis that preceded it.
221
S. Gjerstad, V.L. Smith, ‘Monetary Policy, Credit Extension, and Housing Bubbles: 2008 and 1929,’ Critical Review
21:2-3 (2009) 278
222
M. Slatter, A. Beer, ‘Evictions and Housing Management: Toward More Effective Strategies,’ Working Paper
Australian Housing and Urban Research Institute (2004) 8-12
68
4.3 In-depth analysis of the booms, busts and flat periods

The long-term and fundamentals analysis above gives us an idea of the structure and long-term price
movements of the housing market. But what factors are behind the specific booms and busts and
what happens (or does not happen) during flat periods? And let us not forget the bubbles, which
booms are bubbles, and how did these booms become bubbles? For this I will present an analysis of
each specific boom, bust or flat period. The analysis for this section has been based on the results of
the previous long term analysis (see chapter five), in which the case will be made that the ability-to-
borrow is the main element in the housing market, at least during boom periods. This analysis will be
completed with unemployment and consumer sentiments figures, that seem to be more influential
during downturns. The fundamentals are split in different groups, also based on the outcomes of the
previous section. The fundamentals like building cost and rents seem to present more of a basic level
for housing prices, but are not very influential in the mechanism behind price deviations. So it is all
about money, which was already an important conclusion from chapter two. Would-be buyers
borrow the maximum and buy a house that somewhat equals this amount. I have to make two
remarks about savings. Of course people do save in order to buy a house (for the down-payment), but
I argue that this has limited effect on the housing market and secondly that this is partly incorporated
by measuring the impact of income. Saving rates are at relatively low levels of gross income,
especially if we take out forced savings, which cannot be used for buying a house (like pensions),
which results in just a few percentages of gross income. Changes in the savings level (say from 3
percent of gross income to 3.1 percent of gross income) are simply not capable of strong impacts on
house prices which have reached seven times the multiple of total gross income. There is of course
another factor that influences savings, which are rising house prices themselves. But again, this can
only be used by selling the house or monetized through an extra mortgage (the latter brings us back
to the ability-to-borrow).
The ability-to-borrow analysis is like the growth accounting measures used for dissecting
GDP growth figures. 223 The argument is that ability-to-borrow is the main driving force for housing
prices, based on the analysis done in chapter five. These elements include the generally included
parameters of income and interest (in this case long-term interest) and the added component of
leverage (for explanation see previous section). To adjust each parameter for the actual impact during
the specific period, each parameter will be corrected for the correlation as measured for each specific
period. The interest parameter is of course corrected for its negative correlation figure, as a declining
interest will result in a growing ability to borrow. As none of the parameters will have a correlation
of one (or minus one), there will be a fourth parameter, which will be indicated by the label “other”.
223
O. Blanchard, Macroeconomics. 4th Edition (Upper Saddle River 2006) 213-216
69
If this parameter is significant in the impact on the house price deviation this, this parameter will be
explained further, either by specific events during the period under review, but preferably by other
quantitative parameters like unemployment or consumer confidence. The ability-to-borrow analysis
shows the different impact of a few parameters, which will be necessary to answer my main
question, which was the main factor in creating the housing bubbles. If the regulatory effect was
most important, the leverage parameter should have the main impact, if the monetary authorities are
the main villains, the interest parameter should show the strongest effect. The income level is a
fundamental element, if this is the main parameter, the bubble might not be called a bubble as it is
not deviating from one of its main fundamentals. The analysis can also result in finding other
elements being the main parameter, for example behavioural aspects (which might be captured by the
consumer confidence index).
4.3 Summarizing the analysis

The analysis of the American and Dutch housing markets focuses on a few specific areas, using
mostly a quantitative analysis:
1) Identifying the main driving forces by analyzing long-term trends and fundamentals of the
housing market, based on the earlier theoretical assessment.
2) Creating the analyzing tool ability-to-borrow to understand the impact of the main driving
forces behind housing prices.
3) Understanding some other elements impacting the housing market of which the most
important are the unemployment effect, the behavioural effect and possible the market
structure itself (for example the pro-cyclicality of finance).
70
PART II
The American and Dutch housing markets
71
Chapter 5: Introducing the American and Dutch cases
Housing market news can always count on media attention. Especially since the crash on the
American housing market, there does not seem to be a shortage of bubbles on almost any other
housing market. Market observers see bubbles from China, to Australia to the Netherlands. Remarks
of such bubbles by official institutions like the IMF, for example, lead to all kinds of reactions from
local experts:
“IMF: Dutch Houses overvalued” (…) “An alarming report from the IMF has in the Netherlands, as
well as at the Washington head office, led to some commotion. Researchers from the IMF conclude
that the Dutch housing market has a high probability of crashing”
NOS (Dutch Broadcast Association) on April 2009
But in the same section the news report mentions:

“Dutch specialists disagree with the IMF report. Also the Dutch representative at the IMF in
Washington, Age Bakker, does not agree with the conclusion of his own organisation”
NOS (Dutch Broadcast Association) on April 2009
In 2009 the IMF reiterated its point of view about the Dutch housing market and again it received
strong rejections from several Dutch institutions, like the Dutch Central Bank, the Dutch Central
Planning Bureau (CPB) and the Dutch Association of Realtors (“Nederlandse Vereniging van
Makelaars”, or NVM). 224 It is striking that such major economic institutions reach such contradictory
conclusions. Before the crash in the United States, several economists also aired the overvaluation of
the American housing market, but the Federal Reserve chairman Alan Greenspan even doubted the
existence of bubbles, let alone discuss the extent of overvaluation. 225
224
M. Schinkel, ‘De bel gaat op de Nederlandse huizenmarkt, ’ NRC (jan 2009) 1-2
225
P. Krugman, ‘Greenspan and the Bubble,’ New York Times (August 2005) 15
72
I now introduce a simple graphic (Figure one) with the housing indices of both the Dutch and
American housing market since 1970 (in real terms)
Figure 1 - Dutch and American House Price Indexes (1970 = 100)

300.00
250.00
Dutch
200.00 Housing Index
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100.00
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Housing Index
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Source: See Appendix A & B
At first glance it is tempting to conclude from Figure 1, that if the American housing market
has seen a bubble in the past two decades, the Dutch housing market apparently has seen even
stronger price rises, which must than certainly have been a bubble as well. But prices have to deviate
from fundamentals to become a bubble, so hold on to section 5.6 where you can find my explanation
of the existence of bubbles on both housing markets. Another first impression is that the American
housing market shows some kind of cyclical behaviour with prices rising and declining. The Dutch
housing market shows less evidence of a clear cycle as it experienced a major bubble and crash
during the 1970s, but has been in a rising trend since its low point during the crisis in the early
1980s.
A general remark concerns the apparent correlation between the price rises of both housing
markets. This seems not to be a coincidence. Most OECD countries have seen relatively strong
correlations between national housing markets since the 1980s, with only Germany, Japan and
Denmark showing weak correlations, while the UK, France and Sweden saw very strong positive
correlations. 226 I will revert to this global issue in the conclusion, although I will remark that most
226
K.H. Kim, B. Renaud, ‘The Global House Price Boom and its Unwinding: An Analysis and a Commentary’, Housing
Studies 24:1 (2009) 9
73
research points towards financial globalisation and an oversupply of credit as the reasons behind the
international aspects of the housing bubble. 227
5.1 Identifying the three periods: stable, boom and bust

With reference to chapter four, I have focused on deviations from the general growth trends of
housing prices to identify booms and busts, with an added correction method of changes in the
growth figures themselves. The result of this exercise for the American housing market is shown in
Table 1 below.
Table 1 - American Housing Cycle

Period year quarter duration cumulative change change index figure
Boom 1971 Q3
1973 Q3 9 quarters 4.62% 5
Bust 1973 Q4
1975 Q3 8 quarters -7.85% -8
Boom 1975 Q4
1979 Q2 15 quarters 19.38% 19
Bust 1979 Q3
1982 Q4 14 quarters -11.01% -12
Boom 1983 Q1
1989 Q3 27 quarters 21.20% 22
Bust 1989 Q4
1993 Q1 14 quarters -11.70% -15
Flat 1993 Q2
1996 Q3 14 quarters 0.35% 0
Boom 1996 Q4
2006 Q1 38 quarters 86.49% 95
Bust 2006 Q2
2008 Q4 11 quarters -30.97% -63
Source: See Appendix A
The existence of a boom-bust cycle on the American housing market was already visible in
Figure 1, but this Table adds some interesting elements. First, the booms tend to get bigger over
time, but the downturns are not expanding in the same way. Secondly, between 1993 and 1996, the
American housing market does not move at all for 14 quarters. Thirdly, the boom period of 1996 to
2006 is truly out of proportion of the earlier cycles, not only in duration, but in the extent of the price
rises as well.
227
A. Beltratti, C. Morana, ‘ International house prices and macroeconomic fluctuations,’ Journal of Banking and
Finance 34 (2010) 543
74
Turning to the Dutch housing market, see Figure 1 again, we get a different picture. The
Dutch housing market shows less signs of a boom-bust cycle, as a cycle is not clearly there. But that
is not entirely true. If we take a look at the so-called ‘Herengracht’ index 228 as from 1946, we can
discern a boom-bust cycle, with a major boom period since the 1980s. A boom period that has not
been followed by a major bust, although the housing market currently shows some weaknesses.
Figure 2 - Herengracht Index (1628 = 100)

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Source: www.cpb.nl
228
P.M.A. Eichholtz, ‘A Long Run House Price Index: The Herengracht Index 1628-1973,’ Real Estate Economics 25:2
(1997) 175-192; On his personal site he extended the index until 2008. The Herengracht index has been compiled by
professor P. Eichholtz, it compiles sales prices of the properties at one of the Amsterdam canals (the Herengracht), which
have not changed in size since the 17th century.
75
But my attention is on the period as from 1970, so the next table shows the boom-bust ‘cycle’ of the
Dutch housing market since 1970. The Dutch housing cycle is presented in Table 2.
Table 2 - Dutch Housing Cycle

Period year quarter duration cumulative change change index figure
Boom 1971 Q4
1973 Q4 9 quarters 7.87% 8
Flat 1974 Q1
1975 Q2 6 quarters 0.08% 0
Boom 1975 Q3
1978 Q2 12 quarters 73.86% 80
Bust 1978 Q3
1985 Q4 30 quarters -50.19% -94
Boom 1986 Q1
1989 Q4 16 quarters 19.58% 18
Bust/Flat 1990 Q1
1991 Q2 6 quarters -1.39% -2
Boom 1991 Q3
2001 Q4 42 quarters 101.16% 111
Flat 2002 Q1
2003 Q2 6 quarters -0.02% 0
Boom 2003 Q3
2007 Q3 17 quarters 11.46% 26
Bust 2007 Q4
2009 Q4 9 quarters -6.57% -16
Source: See Appendix B
The Dutch housing market, in contrast to the American housing market, shows mostly strong
upward pressure. There are five boom periods, with only two real bust periods. Also noteworthy is
the fact that many booms are followed by a flattening out period, before booming again. The two
bust periods seem to coincide with major recessions, of which the period from 1978 to 1985 looks
particularly brutal.
76
5.2 The American Housing market: general structure & characteristics

In this section I will focus on three items, the financing structure because of the affordability of
housing, the tax regulations for the same reason and finally a specific characteristic and its possible
influence.
The financing structure of the housing market is strongly affected by the regulations in the
mortgage related sector, which started primarily during the Great Depression. Before the 1930s the
American mortgage market was characterized by mortgages with very short maturities of up to five
years, large down-payments of at least 50 percent of the value of a property and only variable interest
loans, which were non-amortizing (i.e. the loan was to be repaid back or refinanced after a few
years). 229 These kind of mortgages were deemed save investments as housing prices were not
expected to devalue with more than 50 percent. But the depression did push house prices down with
more than 50 percent and this created large potential losses for banks, who stopped lending to the
property market, while simultaneously tried to sell a growing number of foreclosed houses. 230 This
combination pushed house prices further down and led the Roosevelt government to intervene
through the Home Owner’s Loan Corporation (HOLC), which bought eventually one million of
defaulted mortgages from financial institutions and reinstated these with drastically changed
conditions. It introduced long maturities of 20 years with fixed rates and which were fully
amortizing. 231 The government did not have the intention to hold all these mortgages and created the
Federal Housing Administration (FHA) alongside the HOLC in 1934. 232 The FHA was there to
insure the default risk on the HOLC created mortgages so private investors were willing to buy these
mortgages. The HOLC was replaced by the Federal National Mortgage Association in 1938, later
renamed Fannie Mae, which issued bonds (backed by government guarantees) to purchase mortgages
in order to secure liquidity in the mortgage market as the HOLC had done on an emergency basis.
The FHA mostly insured mortgages for low-income borrowers, for which it requested
compliance to standard conditions for mortgages, characterized by fixed-rates, constant payments (of
interest and repayments called annuities) and which were fully amortized. Through these actions the
FHA became the first institution to standardize mortgage terms on a regular basis after the HOLC. 233
After Wold War II the Veterans Administration (VA) also started to insure loans to veterans and
reservists. The mortgage origination was mostly done by so-called savings and loans institutions,
which were depositing institutions (no checking accounts, only long-term deposits) that were paying
229
R.K. Green, S.M. Wachter, ‘The American Mortgage in Historical and International Context,’ Journal of Economic
Perspecitives 19:4 (2005) 94
230
Idem
231
Ibid., 95
232
Fabozzi, F.J., F.P. Modigliani, F.J. Jones, Foundations of Financial Markets and Institutions, 508
233
77
slightly more than the average four percent on Treasury Bills. 234 The rest of the market was
supported by the banks. After the second world war the FHA raised acceptance of loan-to-value
ratios up to 90 percent, but kept a cap on the maximum loan, which created room for private
investors to enter this profitable market (the FHA was very profitable) for larger mortgages. 235
This system worked well until 1966 when the Treasury rates started rising and investors
preferred the higher yielding Treasury Bills over deposits, and thereby created a liquidity squeeze in
the mortgage market. 236 Mainly to secure liquidity to the mortgage market, Fannie Mae was split up
into Ginnie Mae (which securitized FHA-back loans) and another part that was privatised and
allowed to buy and sell non-government backed mortgages in order to increase market liquidity. 237 In
1970 congress also created Freddie Mac in order to specifically securitize the mortgages issued by
savings and loans institutions. 238 So the main reason behind the existence of the two main institutions
intervening in the American housing market, was to secure liquidity through special companies,
which bought the insured mortgages from the FHA and VA, pooled them, and resold these pooled
mortgages as collateral for securities to domestic and foreign investors. 239 This is basically the
supporting system that still exists today, with one important difference. The guarantee system of the
FHA was oriented to the mortgage originating process, but with the growing private securitization
there was also growing demand for insuring the default risks of these securities directly, for which a
solution was found in the unregulated insurance-trading-system called Credit Default Swaps (CDS),
which are essentially freely traded insurance policies, the price of the CDS (which changes through
trading) is in fact the insurance payment, while the liability rests with the organisation that created
the CDS. 240
The above described institutions were normally not directly involved in the housing market as
mortgage suppliers, but more as liquidity suppliers and buyers of standardized mortgages of
mortgage originators. The originators were until the 1980s mostly specialised institutions that were
known by the name of Savings and Loans institutions (S&L), a name that today resonates with the
1980s S&L credit crisis. The Volcker intervention of high interest rates to counter inflation brought
these S&L institutions in major funding problems. 241 They supplied home owners with long-term
fixed rate mortgages, but their funding was already moving away from long-term savings (a move
promoted by the American government), heightened by the cap on deposit rates. The so-called
234
R.K. Green, S.M. Wachter, ‘The American Mortgage in Historical and International Context,’ 97
235
Idem
236
Ibid., 98
237
Idem
238
Idem
239
240
S. Gjerstad, V.L. Smith, ‘Monetary Policy, credit extension and housing bubbles: 2008 and 1929,’ critical review
21:2-3 (2009) 280-286
241
L.R. Wray, ‘Lessons from the Subprime Meltdown,’ Challenge 51:2 (2008) 42
78
“Regulation Q“ capped interest rates for depository institutions, but not for the unregulated money
market funds and other, through financial innovation created, savings options that paid better returns.
This situation created funding issues with S&L companies main funding channel and pushing them
towards the infant wholesale funding market (where they were mistrusted, with higher funding costs
as a result, for their undiversified investment into mortgages). 242 The result was a swift increase in
funding costs (also due to Volcker’s rising interest rates), while their assets (i.e. mortgages) did not
present increasing income (due to the fixed-rates on its mortgages). With a, until then, relatively
minor secondary mortgage market (i.e. securitization), these S&L institutions were doomed. An
important consequence of the S&L crisis was the promotion of the mortgage backed securities to
present mortgage originators with a hedging possibility against their maturity and interest
mismatches. Security was seen as securing liquidity for mortgage originators. Ironically, this solution
is now considered as one of the main culprits of the current crisis.
Other changes during the 1980s consisted for example of the elimination of interest ceilings
(like in all other advanced economies) and increasing competition on the financial markets, where
banks and non banking financial institutions (NBFIs) were increasingly competitive. The traditional
system of long term relationships between lender and borrower was fading in the 1980s (a system
that was especially normal with the specialised S&L institutions). Instead of long term relationships,
mortgages were supplied based on standardized credit quality assessments packaged in standardized
mortgage contracts. 243 The mortgages were also not kept on the books of originators, but
increasingly packaged and resold as securities to other investors. The whole system was insured by
the government backed institutions Fannie Mae and Freddie Mac, but also by some commercial
insurers. 244
The standardization of the assessment was mostly based on two quantitative underwriting
standards (as set by the insurers), namely the payment-to-income ratio and the loan-to-value ratio. 245
The first ratio determines the amount the house buyer can borrow, and the second ratio determines
the protection of the lender against a loan default. These ratio’s are accompanied by general
statistical research about overall default rates of specific groups (related to age, background, income
level, etc) and other statistical data-mining. The result, in the current computerized world, is that
applicants can receive mortgages even through the internet, without any personal contact with the
originator. The structure of these standardized assessments do not take any kind of leverage of the
242
Ibid., 43-44
243
Fabozzi, F.J., F.P. Modigliani, F.J. Jones, Foundations of Financial Markets and Institutions, 503-504
244
245
79
borrower into account, an important element that will show up in the leverage element I use in the
quantitative analysis.
So the government intervention has been largely the result of solving crises, but intervention
policies do not seem to have been proactive towards new developments. As the new developments in
the mortgage market, mostly from unregulated financial innovation, could in turn become
destabilizing. The securitization process was there since the creation of Fannie Mae during the
1930s, but really started to play a role when funding of the mortgage market through deposits
became impossible (with the high inflation and interest rates and subsequent collapse of the S&L
institutions) and the wholesale market became the most important funding source. With heightened
competition and the need for mass standardization, the decline of relationship banking seems, with
hindsight, to have been almost inevitable.
Now let us turn to the tax regime in relation to the housing market. The taxation regime in the
United States is biased in favour of homeowners through subsidies and income tax deductions
(mainly mortgage interest deductions). 246 The assessment of the impact of the tax regulation on the
housing prices, beside the fact that the tax regime stimulates homeownership 247, is difficult to assess.
This is firstly due to its complexity, where the impact is different for different income groups (the
more you income tax pay, the higher your deduction possibilities), but also for the many so-called
special interest groups (special tax privileges for low-income earners, but also for some
minorities). 248 Although the federal income tax and deduction schemes are equal across the whole of
the United States, many differences in state tax regulation creates an even messier picture of the
impact of tax regimes. 249 Regarding the impact on housing prices, most research does point towards
the absence of significant continuous impacts, but changes in tax regimes can result, albeit
temporary, in noticeable changes in housing prices. I will discuss two of the main tax regimes
regarding housing, namely mortgage interest deductibility and starter subsidies.
First there is mortgage interest deductibility. The United States is one of few countries, who
have full mortgage interest deductibility (one of the others are The Netherlands). It is also a costly
tax regime, in 1999 the American homeowners filed for 773 billion dollars in mortgage interest tax
deduction. 250 Beside this huge amount of “lost” taxes, there is another element that makes many see
it as a monstrosity. As it is deductible from income it favours the wealthy, which is true for all
deductions (the ones which are not capped against use by high-income earners are the exception). 251
246
E.L. Glaeser, J.M. Shapiro, ‘The Benefits of Home Mortgage Interest Deduction,’ 14
247
Idem
248
P. Englund, ‘Taxing Residential Housing Capital,’ Urban Studies 40:5-6 (2003) 937
249
Idem
250
251
Idem
80
Some proponents argue that it stimulates homeownership, but the ownership rate has not seen an
upward movement since the 1950s (it stayed between 63 and 68 percent). 252 Another much cited
benefit is related to the social benefits of homeownership. Homeowners have a stake in the quality of
their house and their neighbourhood and tend to put more effort in rising the quality (or at least
keeping it at an equal level) through maintenance, social activities and political activism. 253 Glaeser
and Shapiro (1999) do make a reservation on this assessment, as it might be due to the fact that these
social benefits are related to the social groups that are normally homeowners (richer and older
people), instead of being related to homeownership. 254 A final effect of the deduction is that it
incentivise high gearing (high loan-to-value ratios) of home ownership, which might create problems
of its own. If during a recession house prices decline, homeowners might loose their entire equity
(which was the house value minus the mortgage) and thereby loose the ability to make a down-
payment for a new house. This can keep homeowners stuck in high-unemployment areas, while
without house price declines they would have moved to an area with better employment prospects. 255
Overall, there seems little evidence of real benefits of mortgage interest deductibility, especially in
relation to the large amounts involved. On the other hand removing the mortgage tax deductibility
can have a huge impact on affordability, as it makes mortgages far more expensive for borrowers.
Removing the tax deductibility can therefore put downward pressure on housing prices. 256
International experience shows that this effect of downward pressure can be alleviated by running
down the deductibility over many years (for example in Belgium, Norway and the UK), so that the
inflation rate will avoid problems for homeowners and their mortgages vis-à-vis house values (which
are related in nominal terms). 257
Another way of subsidizing homeowners is through direct subsidies, either through grants
(like first-home-buyer grants) or through tax-exemptions (like scrapping stamp duty for starters). The
effect of these subsidies are also not very clear. Looking at grants, the first effect is that it does not
solve the problem of the lack of affordable housing. Thereby grants and subsidies tend to grow in
value, or are introduced, when house prices become unaffordable not before, again it looks like
symptom control instead of tackling the real problem of affordable housing. Stamp duty exemption
has more proponents, as it does not hand over money to specific groups (especially builders are fan
of grants, as they are the main beneficiaries of these hand-outs), and do make housing more
252
253
Idem
254
Ibid., 30
255
256
J. Swank, K. Kakes, A.F. Tieman, ‘The Housing Ladder, Taxation, and Borrowing,’ Erasmus University Working
Paper (2002) 5
257
P. Boelhouwer, M. Haffner, P. Neuteboom, P. de Vries, ‘House Prices and Income Tax in the Netherlands: An
International Perspective,’ Housing Studies 19:3 (2004) 423-424
81
affordable for starters, although it again fails to make housing more affordable in general. 258 Overall
taxation does not have a big impact on the housing market and also not on housing prices, although a
sudden elimination of deductibility can create downward pressure.
Another post World War II characteristic was the creation and the move to the suburbs away
from the inner city apartments. Americans have moved to ever larger houses, which were mostly also
becoming more luxurious. This change in housing quality has sometimes been used as an
explanation for rising real prices. 259 These larger and more luxurious houses are of course also more
expensive to build, so we will revisit this debate when reviewing the rising building cost in the next
section with long-term trends. Another element of the move to the suburbs was that single-family
housing is more suitable for owning than large apartment blocks (as common elements with other
occupants creates problems of free riding). Most inner-city apartment blocks were (and are) rentals,
so the move to the suburbs created a large rise in the demand for owner-occupied housing. 260 But
with a constant ownership ratio since the 1960s, this effect was most apparent during the 1940s and
1950s.
258
W.A.V. Clark, M.C. Deurloo, F.M. Dieleman, ‘Entry to Home-ownership in Germany: Some Comparisons with the
United States,’ Urban Studies 34:1 (1997)14
259
E.L. Glaerser, J. Gyourko, R.E. Saks, ‘Why have housing prices gone up,’ AEA Papers and Proceedings 95:2 (2005)
333
260
82
5.3 The American housing market: long term trends & fundamentals
In this section I will discuss several general parameters (introduced in chapter four), like GDP, in
relation to housing prices. This analysis will give an overall picture of all the elements in play over
the period as from 1970 until, mostly, 2008. A specific analysis of the individual boom, bust and flat
periods will be done in the next chapters.
GDP, Inflation and unemployment

These general economic parameters can have an effect on housing values. For GDP though, the
causation is mostly from housing investment to GDP according to many researchers, as housing
investment generally results in al kinds of related consuming, from services by realtors to
furnishing. 261 Rising GDP results often in rising income levels and therefore indirectly affects the
housing market, but I will address this affect when talking about income. Inflation has of course a
direct effect on nominal housing values, but some argue for a real effect as well. Inflation makes
money as an asset less valuable. Rising inflation therefore can lead to a flight to safer assets, like
stocks and real estate. Rising inflation therefore can result in rising real prices. Unemployment can
have two effects, firstly declining unemployment results in more people being able to get a mortgage
and buy a house, but indirectly, declining unemployment usually also results in higher confidence
levels with consumers, who then are more willing to make large investments, like housing. Do we
see long-term effects of these parameters versus housing prices?
Figure 3 - American Housing Prices - GDP, Inflation, and Unemployment

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real houseprice
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S.G. Cecchetti, ‘The Brave New World of Central Banking: Policy Challenges Posed by Asset Price Booms and
Busts,’ National Institute Economic Review 196 (2006) 107-108
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As expected the correlation between real GDP and real housing price index is strongly
positive with a value of 0.82. The positive relationship is of course the result of a positive effect on
income and the positive effect on consumption from rising housing investment, which in turn is
normally the case with rising housing values.
Unemployment does not show a strong correlation with the house price index, there is a
weak, but existing and significant, negative correlation of -0.44. So a rising unemployment level will
have a negative effect on housing values. Causation will be more difficult to establish as rising
unemployment will not only make less people able to buy a house, a declining house value will
either be the result of declining housing investment and/or result in declining housing investment. As
I stated above housing investment has a strong effect on economic growth and naturally from the
nature of its relationship, also a strong effect on unemployment.
The relationship between the change in inflation levels and real housing prices seems not to
be affected by an asset flight into safety, as the correlation is negative -0.33. It seems more likely, as
many behavioural economists argue, that people identify low inflation with good economic
performance and good economic circumstances. 262 Low inflation will then result in stronger house
prices and vice versa.
Income, house prices and mortgages

As already discussed in Part I, the income level can be considered to be one of the most important
fundamental parameters for housing prices. People’s income determines for a large part how much
they can borrow. But leverage is not one of the most assessed elements, if a borrower can pay the
interest (even though interest rates might be at all time low levels) and the value of the house covers
the total loan amount, a borrower can get many multiples of his income. Credit risk assessments
should increase the risk profile for highly leveraged borrowers 263, but in reality most lenders do not
bother to take leverage into account. This phenomenon seems to be strongly supported by the
standardization process, where the mortgage application process is focused on ability to pay the
interest (versus the current interest levels) and the house value (even though this might be
overvalued).
But the use of these parameters might prove more difficult. Total mortgage levels are
available, but these discern any diversity within the researched population. There are some specific
figures available, although these often only refer to the specific organisation that supplied the figures
262
S.E.G. Lea, ‘How to do as well as you can,’ edited M. Altman, Handbook of contemporary behavioural economics.
Foundations and Developments (London 2006) 290
263
A rising leverage is normally being complemented by a rising credit risk, which in turn should require a higher risk
premium in the interest rate.
84
(for example figures from the Federal Housing Finance Agency (FHFA), as is used here). But
combining different sources of information will create comprehensive understanding, so I will now
turn to the compiled figures.
Figure 4 - American Housing Prices - Income and Leverage

1,800
1,600
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income
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In Figure 4, three nominal figures are shown, median income of households, median sales
price of houses and the average mortgage per existing house. Median income of households is the
preferred income figure as it takes into account the rising level of two-income households and the
rising acceptance of using two incomes for one mortgage application since the 1980s. As I have
already stated, income is an important parameter for housing values. But the equal rise in housing
prices and income until the year 2000 does raise some questions as well. As I will discuss later on,
the interest rate has been declining since the mid-1980s. This increased the ability to borrow, which
would imply that I could expect a diverting house price from income levels since the mid-1980s.
Furthermore the interest was at its highest level in more than 2 years when the house price rises
divert from the income levels at the end of the 1990s. Above three figures are highly correlated with
each other, whatever relationship is calculated, the correlation figure is always above 0.90.
The growth of total debt as shown above seems to have had a big impact on housing prices,
but this could have been the result of more people borrowing, instead of more borrowing per person.
Therefore hereunder a closer look at leverage levels is presented to see what actually happened. If
more people borrowed, the leverage level should be relatively constant, a rising leverage simply
means that people borrowed more for the same level of income.
85
Figure 5 - American Housing Debt and Leverage

5.5
5.0
4.5 median sales

price houses vs
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I present three ratio’s in Figure 5. The first is the median sales price of a house versus median
income, which shows how much people need to pay for a house, relative to their income, either with
savings or by borrowing. The second is the average mortgage amount of the FHFA versus median
income. This shows that the rising purchase price has been paid for through mortgages. It needs to be
noted that the Federal Home Loan Banks (which figures the FHFA supplies) uses relatively strict
standards for its mortgages, or in other words, it does not act as a subprime lender. 264 The third ratio
shows that the overall mortgage debt level has been rising. It is not an exact figure, but it indicates
that overall Americans have received higher mortgages against their income levels, with rising
household leverage as a consequence. This finding has two consequences, first it raises doubts about
the risk assessment capabilities of financial institutions (and point towards New Keynesian views of
an imperfect credit market) and secondly it confirms my proposition of chapter two that would-be
buyers simply try to get the highest mortgage amount possibly in order to buy a house.
If we look at the relationship between total mortgage debt (statistic from national bureau of
statistics) and the nominal median sales price (as stated by Robert Shiller) we find a very strong
positive, nearly perfect correlation of 0.99, and the total mortgage debt versus the real house price
index still has a positive relationship of 0.93. This suggest that leverage has a strong relationship
with housing values, which will therefore be one of the main factors investigated in the later
chapters. To support this assessment, if we take the FHFA mortgage-to-income ratio versus the real
house price index we still find a strong positive correlation of 0.87. The question remains, why
lenders did not assess rising leverage with rising credit risk, which would have slowed borrowing
capacity of average income earners.
264
86
Households & Housing Stock

An element affecting the United States housing market is its strong population growth, partly due to
immigration, combined with a move to the suburbs and bigger houses. A growing population can
lead to pressures on the housing market, although this can result in local pressures and a diverse
national picture. But, as I mentioned in Part I, every family needs a home, so comparing the number
of households with the housing stock might show overall pressures. Mind you, these national figures
can be misleading, but as the bubble was almost universal over the whole of the United States 265, if
these pressures play a role, it should show this also on aggregate levels.
From Figure 6 it is clear that the American housing market had a consistent surplus of housing stock
versus the number of households, so beside regional and local pressures, there seems to have been no
national shortage of homes.
Figure 6 - American Housing stock and number of households

140,000,000
120,000,000
100,000,000
Nr. households
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60,000,000
housing stock
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It seems that housing supply kept up with population growth and long term demographic
changes did not result in a shortage of housing at any point of time in the last 40 years. But lets focus
on the gap between the households and housing stock. Changes in the gap can point towards
pressures in supply, even though overall there is a surplus. If we take a look at Figure 7, we see that
in the long run the surplus has been growing, so no reason for a bubble there, but there is a short-
lived, but strong reversal during the late 1990s, early 2000s, that might indicate that, at least a
perception of, a lack of housing supply supported the upward price pressures. The growing gap
between housing stock and the number of households also raise doubts about the supposed negative
265
M.C. Wheaton, G. Nechayev, ‘The 1998-2005 Housing “Bubble” and the Current “Correction”: What is different this
time?,’ Journal of Real Estate Research 30:1 (2008) 5; except Texas, all regions have seen strong to very strong real
price rises, especially over the period 1999-2005.
87
effect of rising restrictions on new building projects, although most negative effects were on housing
prices, not volume. 266
Figure 7 - Gap between number of households and housing stock

14,500,000
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average gap
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Short term supply pressures can have an effect in a short term upwards price pressure that can
be self-sustaining as seen in Part I. For example through its market mechanism (local networks
perspective, see chapter two) or through behavioural aspects. I therefore give another view of the
households versus housing stock in Figure 8 below, with growth figures of both parameters.
266
E.L. Glaerser, J. Gyourko, R.E. Saks, ‘Why have housing prices gone up,’ 331-332
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It needs to be noted that the average growth figure of the number of households or housing
stock has seen an equal 0.4 percent of quarter to quarter growth over the entire last 40 years. So even
though there is a bit of oversupply, the currently often heard notion that the US has seen a lot of
speculative building due to the bubble 267 should not be simply accepted as a mere fact. The current
oversupply in the market (calculated as number of housing for sale times the number of house sold
during the last period) is probably more the result of a collapse in demand. 268
Figure 8 - Percentage Change American Housing Stock and Number of Households

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E.L. Glaeser, J. Gyourko, A. Saiz, ‘Housing supply and housing bubbles,’ Journal of Urban Economics 64:2 (2008) 5
268
Ibid., 15
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Building costs as fundamental value

The value of a house, of course excluding the land value, should be linked to the rebuilding cost of
the house (as already noted in chapter two, this is not entirely true for houses with historic features).
At least that, as explained in Part I, should be expected. But Figure 9 shows a different picture.
Figure 9 - American Housing Index and Real Building Costs Index

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Real building costs have been in a declining trend since the early 1970s. Correlation
calculations between sales prices of either existing houses or new houses both show a negative
correlation (-0.4 for existing houses and -0.56 for new houses). As explained in chapter two the value
of a house can be assessed by its rebuilding cost. But if building costs have declined, while housing
prices have risen this suggests that it is not the building value that represents the rising housing
prices, but the other parts that encompass overall housing value, most probably land value.
Especially Morris Davis and Jonathan Heathcote have argued in a 2007 article that the house
price increases are due to strong rises in land values (and therewith offer a justification for the strong
rises in housing prices). 269 I will not dismiss their research outright, as there is a justification for
rising land prices in relation to the prices of houses themselves (which according to the rebuilding
analysis above has seen a decline). This justification is related to the rising economic growth, which
makes land more valuable around cities as its potential profit (or GDP per m2 in simplistic terms) is
also expected to rise. On the other hand I do consider there are some problems with their calculation
and especially their reasoning. Their calculation is derived from taking housing prices minus
building costs (and some other factors like depreciation, see imputed rent calculations in chapter
two). Although I agree with the fact that the growth in value is therefore technically in land and not
269
M.A. Davis, J. Heathcote, ‘The price and quantity of residential land in the United States,’ Journal of Monetary
Economics 54 (2007) 2595-2620
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in house structures, it does not offer a reason why these land values has experienced such strong
rises. Their explanation for these strong rises in land values is based on the argument for a lack of
available land as the number of households had been rising faster than the number of new plots
available (land outside cities is considered to be a poor substitute at best). As shown in the section
“housing stock versus number of households” I think this argument is inherently weak due to the
overall oversupply of housing in combination with an overall price explosion (I will not argue
against some local supply pressures). Furthermore, the fact that people prefer short commutes to their
work in inner cities is indeed an explanation that land values close to cities should rise (this is their
reason why outer city land is not a substitute to inner city land), but why would these values see an
explosive rise based on this argument, when that did not happen in earlier periods? Especially if we
consider income to be a fundamental, why has prices not diverted earlier based on this argument
(suburbs, outer city building, and urban planning has been an issue since the 1950s)? Finally, just
like with housing supply, people are only able to pay as much as they can borrow, whatever they
prefer or whatever the shortage of land. The shortage of supply will certainly lead to upward price
pressures, even in imperfect markets, but in my point of view it is not able to explain the price
explosion in house prices (or land prices as you will) during the 1990s and 2000s. On the other hand,
if one chooses for this argument they have to find a good explanation for land valuation instead of
the shortage of supply. Although this is not necessary in New Classicist theory, as according to the
Classicists there is no reason to suspect market failure, so no reason to suspect other influences than
supply and demand. But if the housing market as a whole is an inefficient market, than the partial
land valuation is also the result of this inefficient market and other factors might play a role. Overall
I do think that the argument of pricier inner-city land is a good argument for upward pressure on
housing prices, but it is not a good explanation for the exponential price rises. I think the problem
with their argument is comparable to the gap between the reasoning behind the rational bubbles in
chapter three and the actual price explosions that these rational bubble theory tries to explain.
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Housing prices and interest: affordability

Lower interest rates make people able to borrow more for the same amount of interest. Mortgages are
normally based on long term interest rates, although the rising popularity during the 2000s of
Adjustable Rate Mortgages might have made the impact of lower interest rates on mortgage rates
bigger (although a major part of all mortgages is still based on long term interest rates and has at
least a medium term fixed rate period). 270
Figure 10 - American Housing Prices - Affordability and Interest

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I have constructed an “affordability index”, which is calculated by taking long term interest
rates times the median sales price of a house (i.e. how much capital costs a median house would
have) divided by the median income. This index tracks the long term interest rate for most of the
time, but is diverted in the 2000s due to rising housing prices, which makes housing less affordable,
even if interest rates were declining. The effect on housing prices though seems mostly absent, as
this index has a correlation of around -0.20 with housing prices (either related to median sales prices
or to average mortgages). Turning to the plain interest rates, both long and short term interest rates
have a negative correlation with real house prices of respectively -0.58 for long term rates and -0.43
for short term rates. In combination with debt levels (see also Figure 5) declining interest rates and
rising leverage can be seen as the main elements behind a price bubble. I will return to this issue in
the next chapter. One last remark with regard to the interest rate gap between long and short term
interest rates and the gap between long term interest rates and inflation. Investors might borrow short
to invest in other assets when the interest rate gap is large, especially if these assets are more related
to the long term interest rates. The inflation gap might be relevant if investors want to take advantage
270
J. Krainer, ‘Mortgage Choice and the Pricing of Fixed-Rate and Adjustable-Rate Mortgages,’ FRBSF Economic Letter
3 (2010) 2
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of low or even negative real interest rates by borrowing cheap and investing in assets. But both
parameters have only low or no correlations with the real house price index. The interest gap has a
correlation of zero, while the inflation-interest gap has a very low correlation of minus -0.17.
Rent gap and rent-to-value ratio’s

Rent is one of the main elements in many calculations of fundamental housing values, as it represents
the income of property investments. The problem, as already indicated in Part I, is that these
calculations have some inherent problems.
Figure 11, clarifies two things. First it points out that real actual rents rise only marginally,
while real actual house prices show a boom-bust cycle. Secondly, if imputed rents, or rent-gap-
analyses, are based on actual real house prices or their equivalent mortgages it will show the effect of
rising housing prices on potential rents.
Figure 11 - American Housing Prices and Rent

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Christian Hott and Pierre Monnin have calculated the fundamental valuations of the
American housing market using rent models (see Chapter 2), either the rent-gap model (actual rents
versus imputed rents) and the supply/demand models (imputed rents as a function of income). 271 In
Figure 12 you can see the result of their calculations versus the real housing index.
They argue that the link between fundamental values (based on imputed rents) and actual
values only appear in the long run (if any link is apparent at all) and that the “Supply and Demand”
model shows the strongest link between the rent fundamental and housing prices. They also argue
that the Supply and Demand model (essentially housing prices versus income) is a good predictor of
271
C. Hott, P. Monnin, ‘Fundamental Real Estate Prices: An Empirical Estimation with International Data,’ Journal of
Real Estate Finance and Economics 36 (2008) 429
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future housing prices as they work with expected values (based on statistical trends of past
observations). As criticism, the Supply and Demand model seems to follow the house price corrected
for changes in interest rates (its index starts rising when interest rates decline and the rises are further
supported by rising house prices), while the rent model is less volatile, due to the above showed flat
trend of the renting prices. So it should be expected that the “Supply and Demand” model shows a
stronger link with housing prices as the rental market (on which the rent model is mostly based) is
only weakly linked to the housing prices, if at all. For backward analysis the model seems to blur the
effects and Figure 11 seems more useful. Christian Hott and Pierre Monnin do point out that even
though in the long run fundamentals do determine house price changes, in the short- to medium run
these rent based fundamentals do not show any link with house price changes. 272 This remark does
point towards the existence of a bubble in housing prices.
Figure 12 - American Housing Prices - Rent Model and Supply-Demand Model

150
140
130
House Price Index
120
110 Supply & Demand

Model
100
Rent Model
90
80
70
1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Source: C. Hott, P. Monnin, ‘Fundamental Real Estate Prices: An Empirical Estimation with International Data; Please
note that Hott and Monnin use different indexes than used in the rest of this paper.
272
Ibid., 441
94
5.4 The Dutch housing market: general structure and characteristics

Just like the American case discussed in section 5.2, first the financing structure of the housing
market will be described, followed by the tax regime, but then some characteristics of the Dutch
housing market, which are in contrast to the American housing market.
The Dutch have seen a shortage of housing for most of the 20th century, which the
government has tried to solve with either stimulation of private initiatives or outright public building
projects. In 1920 the government wanted to initiate more private investment, as public build
“emergency housing” had not solved the issue. 273 Therefore it introduced mortgages with municipal
mortgage guarantees in 1920. After 1920 there was indeed a rise in the building activity274 and
perhaps due to this success, the system of municipal mortgage guarantees survived until 1992, when
it was replaced by a national mortgage guarantee system “de Nationale Hypotheek Garantie” (NHG),
although it was set up as an insurance (participants have to pay a fee), the government ultimately will
always back the system (like Fannie Mae and Freddie Mac in the United States). 275 The NHG
continued its guarantee for mortgages up to a certain amount, currently for mortgages up to
€350,000. 276 An important difference, and important right to exist for the NHG, is the mortgage
characteristic of full recourse, which means that if the sale of a foreclosed house yields less than the
mortgage, the borrower is liable for the residual mortgage obligation (this in contrast to the United
States). 277
Just like the American market, the Dutch market has also seen strong standardization of the
mortgage application process, with declining relationship banking based assessment and strong rising
standard processes. 278 This standardization in combination with the NHG guarantee system has also
supported the securitization of the Dutch mortgage market, but this really began to be implemented
in the second half of the 1990s (Dutch mortgage securities made up 20 percent of all European
mortgage securities in 2008 279). Direct government involvement in stimulating securitization is
absent, in contrast to the American housing market. The Dutch intermediary process has seen
standardization, but instead of a move away from relationship banking, the Dutch intermediary
process was and still is done primarily by financial advisors, who are mostly unrelated to a specific
financial institution.280 They receive a large part of their income from a fee by the selected mortgage
273
J.M.J.F. Houben, Kwaliteitsbeleid voor de Nederlandse Woningvoorraad (Delft 1989) 41
274
Idem
275
M. Cosemans, P. Eichholtz, ‘De Nederlandse Woningmarkt in Crisis,’ ESB 94 (2009) 46
276
Stichting Waarborgfonds Eigen Woningen, Jaarverslag 2008 (2009) 23
277
M. Cosemans, P. Eichholtz, ‘De Nederlandse Woningmarkt in Crisis,’ 46
278
D. van der Wal, H. Lub, ‘Housing finance in the Netherlands – the impact of structural developments on households
and banks,’ BIS-IFC Bulletin 31 (July 2009) 82
279
Ibid., 89-90
280
D. Brounen, ‘De Hypothecaire Revolutie,’ Economisch Statistische Berichten 4313 (2001) 501-502
95
provider (based on the total mortgage amount). This fee-based system has called into question the
unbiased opinion of the advisor towards the prospective borrower. 281
As already mentioned in the American section above the Dutch tax regime also allows full
mortgage interest deduction (introduced in the early 20th century) and all of the ills are also discussed
for the Dutch case, especially its high costs and limited effects. 282 Although the debate has partly
diverted the reasoning away from stimulating homeownership towards its original intent. The
original idea was that the mortgage interest was a cost to be made to realize income from the home
one owns. This cost element had to be corrected against the income from the investment and as the
income of a home is supposed to be rent, the owner is also charged for a fictive amount as it is
considered to be income-in-kind. 283 An interesting element in this calculation is the impact of rising
house prices, with a rising deduction from rising mortgage interest amounts, while the income-in-
kind calculation has been relatively stagnant. 284 The income-in-kind should be calculated as imputed
rents, but homeowners have successfully resisted these needed rises, even though rises would have
been very reasonable from the same logic these homeowners use to argue in favour of keeping the
tax deductibility, namely that it is a costs incurred (they accept the variability of the cost element, but
not the income part). 285 Finally, even though the “cost argument” seems reasonable, other equal tax
deduction possibilities have been slashed already, and there is a good reasoning to have consistency
in tax regimes and therefore also cancel this type of deduction. 286 The CPB did calculate that
eliminating the deductibility would push housing prices down with possibly nine percent of the
original value. 287 So in the Dutch case people are very aware of the pitfalls regarding abolishing this
deductibility.
The Dutch government has also tried to introduce subsidies for first time buyers as from the
early 2000s, but the conditions were so rigid that not more than a few hundred have used it, so any
impact on housing prices will not be significant. 288
There are also some differences between the Dutch and the American housing market. The
Dutch government has introduced very strict building rules and regulations, which range from the
size of the door to the required equipment in the bathroom, to the colouring of the outside of new
houses. Besides these strict rules for the buildings themselves, the restrictions on potential building
281
F. van Alphen, ‘Zo duur is gratis hypotheekadvies,’ De Volkskrant (2006) retrieved from www. volkskrant.nl
282
J. Rouwendal, ‘Mortgage interest deductibility and homeownership in the Netherlands,’ Journal of housing and the
building environment 22 (2007) 369-382
283
J. Rouwendal, ‘Mortgage interest deductibility and homeownership in the Netherlands,’ Journal of housing and the
building environment 22 (2007) 370
284
Idem
285
Ibid., 373
286
Idem
287
CPB, ‘Hervorming van het Nederlandse Woonbeleid,’ Working Paper (2010) 20
288
VromRaad, ‘Op eigen kracht. Eigenwoningbezit in Nederland,’ Advisory Paper (2004) 65
96
sites is even more onerous. The number of restrictions (and thus the number of the amount of permits
needed) is astonishing and ranges from pollution (air, water, ground, etc) to visual restrictions
(preservation of “open spaces”) and many, many others. That these regulations have stifled building
activity is probably not a surprise. Since the 1980s the building activity has been in a declining trend
and has been below projected requirements ever since. This is even more puzzling because the
Netherlands have a housing shortage since at least World War I.
To solve the bottlenecks on the Dutch housing market, especially the supply side, some argue
for less government interference since the 1980s, but this had the adverse effect, as the amount of
regulations like the ones above have grown since then, while the retreat of the government in
stimulating the actual building of new homes has resulted in not only less builds, but also in a
preference for very expensive houses by builders (which is logical as these houses have the highest
profit margins). 289 Although no New Classicists would support this much regulations, in a way the
Dutch government implemented the Classicists medicine. They led the “market” decide about the
supply and demand of housing, while they focused on rules-based regulation. Of course the problem
according to some of these Classicists, is that there are still not enough free market forces and further
deregulation is the answer (I have to agree that this mid-way solution seems to incorporate the bad of
both worlds, so to speak). 290
Another striking difference with the American case is the strong regulation of the Dutch
rental market. Around 90% of the Dutch rental market is controlled by the Dutch government
through rent control and other strict regulation. Previously the houses for renting were also
government owned, but these have now been privatised (although these entities are now revamped as
foundations without shareholders, with huge cash reserves, which have been supplied by the
government). The rental market is relatively large in comparison to other developed countries with
41% of total housing. The housing shortage has been especially apparent in the rental market, with
waiting lists of up to 7 years (in Amsterdam, where over 80% of housing is comprised of rentals). 291
Even more so than the ownership housing market, the rental market has seen strong swings between
moves to market influences and government interference. This has not resulted in a very good
outcome, as there is still a shortage of (rental) housing, it has seen a strong drop in building activity,
and a large group living in rental houses that are “too cheap” in relation to their income, but who
cannot afford to buy a house and have no incentive to change to the far more expensive private rental
market. 292 The background of the phenomenon of cheap renting, known by the expression
289
Idid., 30
290
W. Buijter, H. van Dalen, S. Eijffinger, K. Koedijk, C. Teulings, A. van Witteloostuijn, ‘Over Goede Intenties en
Harde Wetten van de Woning Markt,’ Tijdschrift voor Politieke Ekonomie 27:6 (2006) 38-40
291
VromRaad, ‘Op eigen kracht. Eigenwoningbezit in Nederland,’ 21
292
Ibid., 38-39
97
“scheefwonen” (lopsided-living), can be found in the characteristics of the group. These people are
(low) middle-income people with an average gross income of €25,000 to €40,000 (2005 levels). With
average housing prices above €200,000 and most new houses being build for the upper market, this
group cannot find an affordable house they can buy. 293
A final remark is that in contrast to the American housing market the Dutch housing market
relates to a far smaller region, which in American terms could be described as a large city and its
hinterlands. In other words the “Randstad” region with Amsterdam, Rotterdam, Utrecht and the
Hague as the city and the rest of the Netherlands as its hinterland. The American housing index as
used in this paper though is also city oriented, as it is based on America’s largest cities.
293
Idem
98
5.5 The Dutch housing market: long term trends & fundamentals
Just like the American case I will discuss in this section the same parameters as in 5.3 about the
American market.
GDP, Inflation and unemployment

The Dutch GDP, inflation and unemployment figures show somewhat similar patterns. The link
between GDP and housing prices is a lot weaker than in the American case with a positive
correlation of just 0.56. That is almost as strong a correlation, albeit in opposite direction, as the
unemployment figures, which have a correlation of -0.51 (stronger than in the American case). The
correlation with inflation is again weakly negative of -0.30, almost the same as in the American case.
Overall the boom of the 1970s seems not to have been supported by these fundamentals. Inflation
was returning to low levels, unemployment was at very high levels and GDP growth was nothing out
of the ordinary, in stark contrast to the bubble. This 1970s boom will be an interesting case to zoom
into in the next chapter.
Figure 13 - Dutch Housing Prices - GDP, Inflation, and Unemployment

275
250
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real houseprice
200 index
175
unemployment
150
index
125
100 CPI change

index
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real GDP Index
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Income, house prices and mortgages

Mortgage debt has seen a strong correlation with housing prices with a positive correlation of 0.87,
which is not as strong as in the American case, although that one was almost perfectly correlated.
Income is strongly correlated to nominal sales prices (positive 0.89), just like the American case. But
income and house prices have not grown in similar fashion as was seen on the American housing
market, which saw similar growth levels up to the latest bubble, while the Dutch case shows more
deviation in the relation to the income level. So were the income levels in the Netherlands not as
supportive of housing prices during the 1980s.
Figure 14 - Dutch Housing Prices - Income and Leverage (1970 = 100)

4,500.00
4,000.00
nominal
median
3,500.00 income
persons
3,000.00
2,500.00 nominal
median sales
price houses
2,000.00
1,500.00
Average
1,000.00
mortgage debt
per existing
500.00 house
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For the Dutch housing market I have no figures of median mortgages (in the American case I
used the FHFA figures, see also Figure 5). But as the American case showed, both of these figures
do give an indication of the impact of leverage. The median sales price of a house reached a level of
7.75 times the median personal income. I do not have a time series for median household income for
the Dutch case, but only median personal income, this figure cannot be compared directly with the
American where the median sales price of a house reached a level of 5.12 higher than median
household income.
But as some have argued that especially the boom of the 1990s and 2000s in the Netherlands
was due to strong rising household income (as more women started working), I have to address this
issue. Therefore I will be using a research document by the Dutch statistical office into the changing
households patterns since 1980 until 2003. 294 One of their conclusions was that the difference
between personal income and household income has seen a strong deviation due to the already
294
J. Verbruggen, H. Kranendonk, M. van Leuvensteijn, M. Toet, ‘Welke factoren bepalen de ontwikkeling van de
huizenprijs in Nederland?,’ CPB Working Paper (2005) 10
100
mentioned effect of the rising participation of women, but this deviation happened primarily in the
first half of the 1980s (perhaps due to the recession more women were “forced” to join the workforce
to support household income), while the ratio has been constant since 1990 (in 1977 the household
income was 13 percent higher than personal income and started rising to reach 30 percent in 1990, a
level that it has seen ever since). 295 I want to make two points regarding this research report. First it
is doubtful that faster growing household income than personal income is the reason behind the
strong house price rises of particularly the late 1990s, as this effect only occurred during the 1980s.
Secondly, if the household income is 30 percent higher than personal income, the ratio of median
sales prices versus household income peaked in the Dutch case at 5.96, which is significantly higher
than in the American case at 5.12, as described above.
Figure 15 shows clear upswings during housing booms, which supports the assertion that
leverage is one of the main reasons for housing bubbles. Note that booms are the result of more
influences, but I will focus on leverage to figure out of rising leverage make a bubble of an
‘ordinary’ housing boom.
Figure 15 - Dutch Housing Debt and Leverage

8.00
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price houses
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295
B. Janssen, M. Hoksbergen, C. van der Ploeg, ‘Het Huishoudboekje van de Nederlanders: 1980 tot nu,’ CBS Working
Paper (2009) 9
101
Households & Housing Stock

As the American housing market has seen a structural surplus of houses over the number of
households, the Dutch had a structural shortage of housing in relation to the number of households.
This continuing shortage might be one of the reasons for the lack of a true boom-bust cycle and a
boom-flat cycle as a result.
Figure 16 - Dutch Housing stock and number of households

8,000,000
7,500,000
7,000,000
6,500,000
Nr.
6,000,000 households
5,500,000
5,000,000
4,500,000
housing
4,000,000 stock
3,500,000
3,000,000
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Figure 17 - Gap between number of households and housing stock

-125,000
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-200,000 average gap
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The growth number of households and housing stock tracked each other, just like the
American case. The upswing of the housing stock in 2008 has already been reversed by a bust in the
building industry in 2009 and especially 2010 (building activity normally takes a longer time to
adjust to new circumstance as projects take several years to complete). The decline in both figures,
just as in the American case, does raise the question what mechanism ensures that building activity
102
makes sure that it does follow the declining trend in the growth of households. As the Dutch housing
market at any time in the past 40 years (or hundred years for that matter) could have used a higher
supply to lessen the housing shortage, there was not an actual motive to lower the building activity. It
might be interesting for further research to understand why the relation between the households and
housing stock is apparently so strong in both markets.
Figure 18 - Percentage Change Dutch Housing Stock and Number of Households

0.90%
0.80%
0.70%
growth of
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households
0.50%
0.40%
0.30%
growth
housing
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103
Building costs as fundamental value

The title of this section actually has merit for the Dutch case. The American building costs did even
show a negative correlation with housing prices as real building costs had been declining since the
mid 1970s. The Dutch case on the other hand shows much stronger correlation with the housing
price index. Not only do we see an equal upwards movement in building costs at the moment of the
rise in housing prices in the 1970s, the subsequent decline and rise afterwards is also there, although
the deviations have not been nearly as excessive as the actual house prices. Looking at Figure 20, it
is no surprise that both parameters show a correlation of 0.95, which highlights that building costs in
the Dutch case are a relevant fundamental (in contrast to the American case), but Figure 20 also
makes clear that building costs follow the swings in the housing market, but the house price swings
are far more pronounced than the relatively benign change in building costs.
Figure 19 - Dutch Housing Index and Real Building Costs Index

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cost index
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Housing prices and interest: affordability

Again the Dutch housing market shows different correlations as the American housing market. The
interest effect seems far stronger in the Dutch case with correlation figures with the housing index of
-0.83 for long term interest and -0.78 for short term interest rates. The effect can be seen in the
affordability index (a combination of rising total debt and declining interest versus income) in
Figure 21. Although with some swings the affordability has been relatively equal during the 1990s
and 2000s, where the effect of rising total debt (needed to pay for rising housing prices) seems to
have been neutralized by declining interest rates and rising income. Whereas the American
affordability index shows that after 2002 rising sales prices had a negative effect on the affordability.
Figure 20 - Dutch Housing Prices - Affordability and Interest

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interest
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long interest
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105
Rent gap and rent-to-value ratio’s

Analyzing the relation between rents and housing prices should be done carefully in the Dutch case.
If we take a look at Figure 21, we see clear support from rising rents for the strong rising sales prices.
The problem with assessing the actual impact is that the Dutch rental market is dominated by semi-
government (until the late 1990s entirely government) institutions, the so-called housing corporations
(‘woningcorporaties’). These privatised institutions take care of 90 percent of the Dutch rental
market, which is also strongly regulated (the government caps annual rent rises, for example). I will
take notice of this result, but will use it in the rest of this paper with care. Next I will also take a look
at the Hott and Monnin research, which they also performed for the Dutch housing market.
Figure 21 - Dutch Housing Prices and Rent Index

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Hott and Monnin have also reviewed the Dutch case in their rent-gap analysis. 296 In contrast
to the other cases (they observed the American, UK, Swiss, Japanese and German housing markets)
there seems to be no link between fundamentals and actual prices in the Dutch case, whereas in all
other cases the fundamentals were ultimately in the long run good predictors of future housing
prices. 297 This supports my hesitation stated above about the disconnection between the Dutch rental
market and its housing sales market.
Figure 22 - Dutch Housing Prices - Rent Model and Supply-Demand Model

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Supply & Demand

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Source: C. Hott, P. Monnin, ‘Fundamental Real Estate Prices: An Empirical Estimation with International Data; Please
note that Hott and Monnin use different indexes than used in the rest of this paper.
296
C. Hott, P. Monnin, ‘Fundamental Real Estate Prices: An Empirical Estimation with International Data,’ 445
297
Idem
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5.6 Deviations and bubbles

In the previous sections I have identified the boom-bust cycle, given a short description and done a
long term analysis of both the American and Dutch housing market. Based on this general analysis it
is now time to add a bubble perspective to the data.
As explained in the previous chapters, I consider the best way to define a bubble as a
deviation from fundamental values. This implies that there is a relation between the fundamental
value and the housing price in the first place, which is not necessarily the case as explored in this
chapter. To review where we stand first a quick review of the possible fundamentals and the findings
from this chapter in relation to the possibility of bubbles, the actual bubble assessment will be done
hereafter:
1. Income
From a theoretical view income is already a strong fundamental for residential house values.
The reason is that owner-occupied housing has no income element of its own in order to
compute any kind of present value price for housing. But in contrast to commercial property,
the sale price is not based on the potential income (corrected for the expected cost element) of
the property. The element that is essential for actual sale prices is the income of the buyer,
which in the end determines the amount a person can borrow. Many other factors do
influence this borrowing capacity, like interest rates, or allowed leverage, but the basic
starting point in any calculation is always income. So deviations in the ratio of income versus
housing prices should give a good indication of the presence of bubbles.
2. Leverage
Normally the leverage ratio (debt versus income) is not considered to be a fundamental and
more seen as a changing variable. The defence of higher leverage levels in the past 20 years
was that lower interest costs made more borrowing affordable, while rising house prices (and
therewith keeping loan-to-value ratio’s within acceptable limits) reduced credit risk (and the
need for a higher risk premium in the interest rate). The problem with this argument is when
rising leverage itself is one of the prime reasons for rising house prices, which should raise
questions about the sustainability of such price rises. For example what if interest rates start
to rise and high leverage levels become unaffordable, prices will decline and the latent credit
risk will suddenly become clear. The mortgage originators should have taken rising interest
rates and declining housing prices into their risk assessment, which would have led to the
need for a rising risk premium in the interest rate (and a lower accepted leverage level).
Leverage levels can broaden the understanding of the housing value, but only in combination
with income. So I do not consider the leverage ratio to be a fundamental element, as it is a
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direct derivative from income. Leverage is an influential factor, but it is the income element
that is the actual fundamental.
3. Building costs
An often cited fundamental of housing prices is building costs. Although this is a defensible
proposition, the problem with this fundamental is that it covers only part of the valuation of
housing prices. The other part of housing prices, land, is at least as important. Although I do
not agree with the reason Davis and Heathcote give as an explanation for rising land prices, I
do agree that land value is a growing part of the overall housing value. This value consists of
a declining part for the building (due to lower building costs), and a rising part for land due to
location issues with cities growing ever wider in size. But the value of land is difficult to
assess, for the same reason of the combined housing prices, as it not really has a fundamental
value. The location issue has only added an extra dimension to the valuation problem. So
building costs is not a good indicator for bubbles in housing prices.
4. Rents
Instead of using income as the main parameter many researchers have tried to take rents as
the income from housing to make a present value calculation. As discussed and shown in this
chapter these calculations are very problematic and it is difficult to create a clear picture. The
reason for this, in my point of view is the connection between the rental housing market and
the owner-occupied housing market. Taking imputed rents instead of actual rents into the
calculation does have problems as well. Within the imputed rent calculation there is the cost
of capital. With rising housing prices, the cost of capital will rise as well. But to argue that
rising housing prices are then supported by the imputed rent calculation as a fundamental
seems to be flawed reasoning. I therefore do dismiss rents as an indicator for detecting
housing bubbles.
The above assessment leaves us one workable fundamentals, of which the income
fundamental should be the prime element (as leverage is influenced by income as well and is
therefore not entirely an independent indicator). Now I turn to the actual assessment of detecting the
existence of bubbles in both housing markets over the period 1970 to 2008.
The definition of a bubble as a deviation from fundamental, points towards defining excessive
deviation in the ratio of the fundamental versus housing prices. So I have taken nominal median
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income versus nominal median house sales prices, divided the sales price by income and therewith
created a ratio of income versus house prices, the blue line in Figure 23. It should not be expected
that the ratio is anything like a constant ratio, as the housing market (the American market for sure)
shows signs of an cyclic movement.
Figure 23 - American house price - income ratio

5.25
ratio of nominal
income versus
5.00 nominal median
sales prices
4.75
lower boundary A
4.50
4.25
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4.00
3.75
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3.00
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If house prices deviate significantly from fundamental values, than the ratio should also
deviate strongly, because if the strong price rises were supporting of the housing price rises, the ratio
would not rise excessively. So I have calculated the standard deviation of the ratio and created upper
and lower boundaries. In principle changes within these boundaries should not be considered
excessive and therefore not a bubble. This is indicated in Figure 23 with the yellow lines, or
boundary A.
But the standard deviation calculated of the entire period is stretched as it has incorporate the
bubble-deviation, as indicated by the ratio moving above the yellow line. To correct the impact of the
bubble on the standard deviation, I have also calculated the standard deviation for the data between
boundaries A. This results in a far smaller boundary, as indicated by the red line or boundary B. If
this is taken as reference point for indicating bubbles, the housing prices were during the period
between 1988 and 1990 also a bit overpriced. Although I do not necessarily want to conclude from
this, but this follows on the crash of the Dow Jones index in October 1987, while the latest housing
bubble becomes one as from the third quarter of 2000, or directly after the crash of the dot.com
bubble. Robert Shiller also makes the case that the crash from the dot.com bubble created a shift
110
from the stock market to the housing market, as people not only lost money during the crash, but also
stopped putting money in stocks, but instead put their reserves into housing. 298
Repeating this analysis for the Dutch housing market proves more difficult. The period of
housing prices is characterized by two strong booms. The strongest boom period from 1991 to 2001
saw excessively high prices, but was also long in duration (for a clearer view of this overall high
levels during the period under research, please take a look again at Figure 2, the Herengracht Index
as from 1946).
There are two specific problems with repeating the same calculation as in the American case
above. First, calculating averages from the historic high prices during much of the period under
research the result will be a higher average (in this case an average of 4.93) of the ratio of housing
prices versus income than over a much longer period might be the case. Secondly, due to the strong
deviations result in a high standard deviation, which might point out more about the mathematical
calculation than the actual affordability of the mortgage up to the upper boundary (the standard
deviation in the Dutch case was 1.44 points, or more than two and half times the American calculated
standard deviation).
Ignoring the problems above and repeating the calculation as done with boundary A with
American case, we get an upper boundary A in the Dutch case of 6.37 points. In this case only during
the 1991 to 2001 boom period the Dutch housing market experienced a bubble in housing prices,
while the strong boom of the 1970s is not a bubble. But, as with the American case this first
calculation is biased upwards.
Figure 24 - Dutch house price - income ratio

8.00 ratio of nominal
income versus
7.50 nominal median
sales prices
7.00
lower boundary A
6.50
6.00
upper boundary A
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5.00
upper boundary B
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calculated
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boundary
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R.J. Shiller, Irrational Exuberance. Revised 2nd Edition (New York 2009) 80
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But I would like to correct two problems in calculating the upper boundaries for the Dutch
case. First the high volatility of the Dutch housing prices disrupts the standard deviation calculation
and the second problem is that the average housing prices (and therefore the average ratio of housing
prices versus income) are historically at high levels during the period under research.
Correcting the Dutch standard deviation downwards can be done by taking the standard
deviation (not the average) of the American housing market (not the low calculation of boundary B,
but the higher standard deviation for the entire period, the boundary A). The American standard
deviation of 0.56 is then added to the average ratio of the Dutch housing market (4.39 points), which
results in an upper boundary of 5.49 as shown as upper boundary B in Figure 24. In this case the top-
end of the boom period of the 1970s is considered to be a bubble, while the extremity in housing
prices since the 1990s becomes ever clearer.
For the second problem, the high average housing ratio, can also be assessed from a different
angle. Instead of calculating averages of the ratio, we can compute the acceptable ratio from micro-
economic or accounting research. As shown in chapter two, housing costs normally make up 33
percent of income levels (either rent or owned). As Edward Glaeser and Jesse Shapiro report 299,
beside mortgage related costs, the other annual costs for homeowners (mostly maintenance and
taxes) represents 3 percent of the value of the house. The mortgage format is a 30-year annuity with a
fixed mortgage rate of 6.88 percent (the long term average of the last 40 years) and is fully
amortizing. 300 If we take median income we can calculate the acceptable ratio, as presented in Table
3.
Table 3 - Acceptable mortgage-income ratio

Acceptable housing cost of gross income 33%
Long term interest rates 6.88%
mdian personal income (2008) 31,000
taxes, maintance and other costs 3%
mortgage characteristics 30-year annuity, fixed rate, fully amortizing
available of income for mortgage related expenses 13,299

taxes, maintance and other costs -4,447
amortization & interest -8,852
0
represents a total mortgage value 111,179

mortgage-income ratio 3.59
If we accept an down-payment of 10% (although in the Netherlands most mortgage

originators do not request a down-payment and even lend up to 125 percent of the value of a
299
E.L. Glaeser, J.M. Shapiro, ‘The Benefits of the home mortgage interest deduction,’ NBER Working Paper (2002) 12
300
P. Cardol, J.C.M. Gruijters, Financiële rekenkunde voor het HEO. 3rd Edition (Houten 2000) 80-84
112
house 301). Then the acceptable housing value will be 3.95. If we take this figure as the average and
add up the standard deviation as used in the American case than we come up with an acceptable
figure of 4.51. I do want to point out that the ratio of 4.51 should also be the case for the American
housing market, with some surprising findings. With this new ratio, the American housing market
still has seen a bubble, but only the tip of the market can be considered to be a bubble, while the
market normally is far from overheating.
On the other hand the result of this kind of calculation changes dramatically with changing
some assumptions. For example, the acceptable housing costs of gross income might be too high in
relation to other expenses, but dropping it just 3 percent to 30 percent, results in a drop of 0.57 in the
mortgage-income ratio to 3.02. Furthermore, long-term interest rates are not equal to long-term
mortgage rates, which might require higher rates to be used. If we push up mortgage rates to 8
percent in the calculation, the mortgage-income ratio drops to just 2.71 points. This number would
put the calculated boundary far closer to the “Boundary B” in the American case, so making
conclusions based on the calculation of Table 3, should be done very carefully.
Overall there is, to my opinion, enough empirical and theoretical support in this paper that the
approach to the problem of valuation can be done like in Table 3. In order to make strong
conclusions, this valuation method will require more research to come up with good foundations for
the assumptions (mortgage rates, etc), as well as a well more research to come up with an improved
calculation framework with more specifications about alls factors involved (like more specified
maintenance and taxes percentages) and perhaps a time-element (i.e. life-cycle approach).
Based on the available upper boundaries here presented, the conclusion must be that the
Dutch housing market has seen two bubbles during the period under research. First the boom of 1971
to 1973 that turned into a bubble very quickly, but which also crashed shortly afterwards. Please note
that even based on household income, in this period less than 17 percent higher than personal
income, the boom of 1971 to 1973 is still a bubble (with for households an upper boundary of 5.3).
The second bubble came out of the 1991 to 2001 boom period. In contrast to the first bubble, the
boom did not become a bubble as quickly, with breaking the “calculated boundary” in 1995 and the
“upper boundary A” in 1999. But the extend of overvaluation versus income levels was far larger
than the 1970s bubble, and perhaps more importantly it did not crash, although there has been a
relatively minor correction in the past two years.
If the sales price is the main fundamental and indicator of bubbles in housing prices, the
American housing market has become a bubble after the year 2000 (with the boundary of 4.56 it
301
VromRaad, ‘Op eigen kracht. Eigenwoningbezit in Nederland,’ 41
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became a bubble in 2004). The period 1988 until 1990 could with the more conservative calculations
also be considered a “light” bubble. The Dutch housing market has been far more unstable the last 40
years, which distorts the ratio of median income versus median sales price. The strong boom of the
late 1970s should probably be seen as a bubble, but the boom in the late 1990s certainly did become
a bubble, with truly excessive ratios. In the next chapter I will review the factors at play during the
boom periods. In the above indicated boom periods that became bubbles and show which factors
made these booms becoming bubbles.
5.7 Concluding remarks: Bubbles, long-term trends & fundamentals

In this chapter I have identified periods of booms, busts and flat periods within the American and
Dutch housing markets. In the next two chapters I will take a closer look at several identified periods.
What should be the emerging picture of this first look at both cases? Hereunder I shortly summarize
several items that seem to be the central elements:
1) the American markets shows a clear boom-bust cycle, as the Dutch market is more a boom-
flat cycle.
2) Income is a good macroeconomic fundamental for housing prices in both cases.
3) Leverage shows particular strong correlation with housing prices and seems to be one of the
main factors behind booms and bubbles.
4) A particular difference between the American and Dutch cases is the consistent housing stock
surplus in the United States, while the Dutch have seen a consistent housing stock shortage.
5) In contrast to the American case, building costs seem to have a strong relation with housing
prices in the Netherlands.
6) Interest levels have strong correlations with housing prices in the Netherlands. Surprisingly
the American case shows far weaker correlations between interest levels and housing prices.
7) Rent as a macroeconomic fundamental can be useful, but a link between the rental market
and house sales market needs to be there. This is the case for the American market, but the
Dutch rental market seems to be detached from the house sales market.
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8) Both the American and Dutch housing markets do have seen bubble forming in housing
prices during the late 1990s, early 2000s. In both markets there are also other cases that might
be considered to be bubbles if a more conservative analysis is used.
115
Chapter Six: Booms & Bubbles
In Chapter five I have discussed the structure of the American and Dutch housing markets as well as
all kinds of factors influencing the house price developments. I also identified different periods of
booms, busts and flat periods. One of the important conclusions was that income, leverage and in a
lesser degree interest rates are the main driving forces behind house price deviations, which
parameters taken together I have named “ability-to-borrow” (see also chapter four). This analysis is
also an extension of the argument in Part I, that buyers generally buy the house they can afford by
utilizing their entire borrowing capacity. In this chapter I will analyze each boom period for the
influence of the ability-to-borrow framework. Changes in housing prices are of course influenced by
other factors as well, hence the addition of the “other” category. I will add information for extra
explanation, for example consumer sentiment, especially if the other category has a strong impact in
relation to the other three parameters. I do want to point out that consumer sentiment indexes are
very volatile and significant changes in the index do not always show up in economic data.
Hereunder I present the consumer sentiment indexes for both the American and Dutch housing
market for the entire period in order to show the high volatility, but also a first indication about the
effects of consumer sentiment. The American case (Figure 25) shows there is a possible but weak
relationship between the housing market and consumer index, which is reflected by a correlation of
0.45. The Dutch consumer confidence (Figure 26) is far more volatile and it is probably no surprise
that the correlation (over the entire period) is non-existent with a result of -0.01. There is a difference
between the American and Dutch consumer confidence figures. The American consumer confidence
figures are a true index with a base year set at 100 (1970). The Dutch consumer confidence figures
also shows if the majority is positive or negative with positive or negative consumer confidence
figures.
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Figure 25 - American Housing Prices and Consumer Confidence

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Figure 26 - Dutch Housing Prices and Consumer Confidence

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The aim of this chapter is mostly to get a clearer picture about the impact of the three main
parameters and to get a more specific view of the influences that create the housing price deviations,
instead of the long term view given in chapter five.
A final remark about the reason I leave out changes in housing stock or changes in housing
supply, because many (especially in the Netherlands) explain rising housing prices from shortages of
houses on the Dutch housing market. Although this is true, it is true for the entire period under
review, either bust or boom. The reasoning that higher prices would stimulate more building activity
also seems unfounded as the opposite has been the experience. Furthermore even with housing
shortages, people are only able to pay a certain amount, mostly based on how much they can borrow.
The shortage of housing probably does effect the market in un upward pressure, but I consider it to
117
be an effect on the structure of the market with a stronger reaction in boom times, than a specific
element behind the price deviations in housing markets.
6.1 The American Booms: why booms become a bubble

Chapter 5 has shown that the American housing market can be characterized by a boom-bust cycle.
But it also became clear that the housing prices were not out of line with long term trends and
fundamentals for most of the period of research, until we reached the latest boom. Income showed a
strong relation until the latest boom, building costs were declining, but until the latest boom the
housing prices and building costs did not show such an excessive gap as during the latest boom. Also
the main ratio’s like leverage and median sales price versus median income were relatively stable
until the last boom.
In this section I will therefore look for the elements what were significantly influential during
the last boom in contrast to the earlier booms. I will discuss the booms from 1970 until today and
will start therefore with the boom of 1971 to 1973. Please note that the scale used in these graphs are
different for each period, as the booms are getting bigger over time. For example, the “other”
category in the first boom of 1971 to 1973 seems to be the biggest impact as seen by the “other”
category for all periods, but percentage wise its half of the “other” category in the latest boom of
1996 to 2006, where the “other” category is of minor importance.
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The Boom Period of 1971 to 1973
Figure 27 - American Housing Boom of 1971 to 1973

5.00%
4.00%
3.00% House Price Index

Income
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Interest
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other
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From figure 27 it is clear that, during the first boom of 1971 to 1973, it was not ability-to-
borrow that created the boom. Income and leverage did have a positive impact on housing prices, but
the rising interest rates almost entirely neutralized this effect. The support for the housing market
might be due to some kind of optimism, here in the “other” category. The economy grew strongly
during the period (over 10 percent in real terms) and unemployment declined from over 6 percent to
under 5 percent. Looking at consumer sentiment, the early part of the boom is supported by a rising
consumer sentiment, but this drops away halfway the boom period.
Figure 28 - American Housing Market and Consumer Confidence

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Figure 29
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The boom of 1975 to 1979 is somewhat similar to the boom of 1971 to 1973, as the ability-to-
borrow was again not a factor of significance. The second boom is a lot stronger, four times, than the
earlier boom. Just like the boom of the early 1970s, this boom was supported by strong economic
growth and a drop in unemployment (a drop of 8.3 percent to 5.7 percent or over 30 percent).
Another interesting element is the high level of inflation (averaging 7 percent and even reaching 10
percent year-on-year in the second quarter of 1979). With reference to Chapter 2 (see the network
perspective), high volatility might lead to disruptions in the price setting mechanism.
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A combination of optimism and high volatility might have been a catalyst for strong price
rises. Looking at consumer confidence there was again strong support at the beginning of the boom,
but consumer confidence fell back half way, just during the previous boom, although this time the
drop in consumer confidence was far less pronounced.

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The boom of 1983 to 1989 can be regarded as a change in the impact of the three parameters.
The housing prices rose as fast as the second boom of the late 1970s, but now it was mostly the result
of the three parameters or ability-to-borrow. It is also clear that rising leverage had become a major
factor in the rising housing prices, which was further supported by declining interest rates and rising
121
income. The “other” category saw a declining significance from the earlier booms. What changed
between these periods? Well of course a declining interest rate instead of a rising rate had a strong
impact. But the parameter that had the biggest impact was leverage, while the 1980s saw the end of
the Savings and Loans institutions and the end of the relationship banking. In other words, it was the
beginning of the standardized loan applications, which focused on loan-to-value and ability-to-pay
(the interest), but did not take leverage into account. This institutional change is the most significant
change between the previous boom and this boom. The influence of consumer confidence on this
boom was not very straightforward. There was strong upward movement in 1985, at the same time
the boom in housing prices took off, but after 1985 consumer confidence entered a slow downward
trend, while the housing prices clearly were rising further.

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The changing composition of the impact of these parameters on the housing prices as seen in
the previous booms continued during the latest boom. The impact of income was zero, as real income
had barely risen during this period. The 1996 to 2006 boom period saw a further overall decline of
interest rates, but it was leverage that became the overwhelming influence on the rising housing
prices. And rise they did, during this period housing prices saw an unique rise in real prices of almost
90 percent, mostly financed by borrowing more. Beside the magnitude of the housing price, the
strong rise of leverage without any significant rise in income should have been of much concern for
mortgage originators, investors and regulators as it meant higher credit risk (i.e. risk of default),
while the mortgage rates (which did track long term interest rates until the crisis) did not seem to
reflect this rising risk factor.
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From Figure 34 it becomes clear that the housing market is at least not primarily driven by
consumer confidence. There was an upswing in the beginning, but overall the confidence index had
been in a declining trend over the period 1996 to 2006, while this declining confidence did not had a
significant affect on the explosion in house prices.

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-Q
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19
124
6.2 The Dutch Booms: a familiar picture?

That booms in the Netherlands are stronger (or in other words, the Dutch market is more volatile) is
clear from the first boom, which coincided with the first American housing boom. It was also similar
in nature, although leverage had no effect at all in this Dutch boom.
Figure 35 - Dutch Housing Boom of 1971 to 1973

10.00%
8.00%
real houseprice
index
6.00%
Income
4.00%
Interest
2.00%
Leverage
0.00%
other
-2.00%
-4.00%
The high volatility of the consumer index makes analysis for a short period as the boom of
1971 to 1973 a bit difficult. There was initially a downturn, but as from 1972 the consumer
confidence rose and turned positive again in 1973. A combination of a stagnant, but very low
unemployment level (at or below 2.5 percent for the whole period), growing income and positive
consumer sentiment seems to be the best explanation for the rising housing prices in the first boom
of the 1970s.
Figure 36 - Dutch Housing Market and Consumer Confidence

125
100
real
houseprice
index
75
50
25
consumer
confidence
index
0
-25
1972 - Q3 1972 - Q4 1973 - Q1 1973 - Q2 1973 - Q3 1973 - Q4
125

80.00%
70.00%
real houseprice
index
60.00%
Income
50.00%
40.00% Interest
30.00%
Leverage
20.00%
other
10.00%
0.00%
The second Dutch boom reinforces the picture of strong housing booms in the Netherlands. It
seems to have been supported by many factors, which means softening the focus entirely on
leverage. As already shown in the previous chapter, the boom of 1975 to 1978 was most probably a
bubble. This conclusion is supported by a rise of over 70 percent in real terms in just three years, a
feat that the latest American housing boom, also identified as a bubble in the latest chapter, took 10
years to accomplish. Rising income (of more than 10 percent in real terms!), declining interest rates
and rising leverage supported the rising housing prices. Other factors were supportive as well, real
rents were rising with 8.5 percent, while real building costs were rising with 7.5 percent. I would also
like to remind people of chapter 2 and the network effect. Local research showed that rising volatility
made the price setting process far more difficult with possible strong reactions as a consequence. The
annual inflation rate of 10 percent at the beginning of 1975 might have pushed people into thinking
that rising prices were to be expected in the near future. But during this period the annual inflation
declined to 3.5 percent in 1978. Supported by an increasing ability to borrow and possibly fooled by
a declining inflation rate, while expecting the opposite, buyers pushed up the housing market to
unsustainable levels, as they would find out during the crisis to come (see next chapter).
126
The housing market also seemed also to be supported by rising confidence figures, although
very negative at the beginning, the rising confidence index shows a positive correlation of 0.72 with
the housing prices.
200
150
real
houseprice
index
100
50 consumer
confidence
index
-50
2
2
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
75
75
75
76
76
76
76
77
77
77
77
78
78
19
19
19
19
19
19
19
19
19
19
19
19
19

25.00%
real houseprice
20.00% index
15.00% Income
10.00%
Interest
5.00%
Leverage
0.00%
-5.00% other
-10.00%
The boom of 1986 seemed to be a reaction to the devastating early 1980s, as rising housing prices
did not find much support by two elements of the ability-to-borrow, as income levels were stagnant
and interest rates were even rising. On the other hand housing prices were supported by rising
leverage. Support from other basic fundamentals might also be part of this late 1980s boom. Even
though the housing market and rental market in the Netherlands seemed detached, a basic notion of
housing cost of buying versus renting might have had some impact, as even during the bust of the
early 1980s, rents had continued their upward trend (a 25.6 percent rise even during the bust period).
127
Other factors that might have been in play is the credit-asset cycle (see chapter 3), where distressed
asset values during a debt-deflation period became interesting to invest in, and prices, supported by a
new credit cycle, started rising again. Although the rising leverage might support that notion, the lack
of a debt-deflation effect during the bust of the early 1980s (real mortgage debt rose with almost 70
percent!) probably dismisses this theory, as only half the explanation fits the story. The consumer
apparently ignored the economy turning positive, as the consumer index was in a downward trend
until the fourth quarter of 1987. The doubtful support of the consumer confidence is also shown by a
weak correlation of just 0.37. It seems that the depressed housing prices after the housing crash and
improving economic conditions combined within a market that was known for its continuing housing
shortage was able to create enough momentum to push up housing prices significantly.

140
120
real
100 houseprice
index
80
60
40
consumer
20 confidence
index
-20
1
4
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
86
86
86
86
87
87
87
87
88
88
88
88
89
89
89
89
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
128

120.00%
real
houseprice
100.00% index
Income
80.00%
Interest
60.00%
Leverage
40.00%
20.00% other
0.00%
With a short break of one and a half year (the bust of 1990 to 1991, see next chapter), in 1991
the Dutch housing market started a housing boom that would last 10 years without being followed by
a bust (after a flat period in 2002 and 2003, the boom continued until 2007). The period did of course
not see as smooth a ride as might be suggested by the graph. The relatively mild recession of the
1990s resulted in a slow down in the growth figure of housing prices, while the fourth quarter of
1999 saw a frantic real house price rise (year-on-year). The support of the housing prices certainly
did not come from rising real income, which was almost stagnant during this period. Declining
interest rates certainly did help, but it was rising leverage that pushed the housing prices through the
roof. This explosion of debt had propelled the Dutch into the upper regions of debt-to-income ratio’s
in the world. 302
302
D. Brounen, ‘De Hypothecaire Revolutie,’ Economisch Statistische Berichten 4313 (2001) 500
129
Consumer confidence was for most of time supportive of the boom period, which is also
shown by the positive correlation of 0.63. But the consumer confidence was not continuously
positive and the direct relation between the two was certainly not clear. At the start of the boom,
consumer confidence was negative and in the period 1992 to 1993 even declined, while the housing
prices were rising. The same was the case for periods in 1995, 1996, 1998 and the period after 2000.
From this mixed picture it is not clear if and how consumer confidence influences house prices.

210
195
180
165
real
150 houseprice
135 index
120
105
90
75
60
45
consumer
30 confidence
15 index
0
-15
-30
91 3
92 4
92 1
92 2
92 3
93 4
93 1
93 2
93 3
94 4
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94 2
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95 4
95 1
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00 4
00 1
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01 1
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01 3
4
19 - Q
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20 - Q
20 - Q
20 - Q
20 - Q
20 - Q
20 - Q
-Q
91
19
So why did the reaction of many Dutch financial regulators (see beginning of chapter five)
seemed to be so in denial of the existence of a bubble, and on what grounds? Take for example the
statistical analysis of the CPB of the Dutch housing market (original 2005, updated in 2008). 303 Their
analysis was mathematically sophisticated, but their argument was based on a set of assumptions of
which they argue are behind the factors for housing price rises. These assumptions include income of
households (a time-series I was unable to retrieve for this period, see chapter five), the interest rate,
household wealth and finally housing supply. Although mathematically more sophisticated, the setup
of the model was, just as mine, based on a particular view of the market structure. By ignoring the
impact of the rising debt ratio’s (which in their calculation is eliminated by taking rising housing
prices into their wealth calculation in combination with debt levels), they automatically had other
factors being the most important, with rising household income and changes in housing supply which
became the main reasons for house price changes. Another element that I find disputable, is that they
used in their calculation an average growth figure of the housing market, just like I did in section 5.2,
but the problem with their calculation was that they started calculating the average growth figure
almost at the same time when the housing market had crashed and was at a very low point in the
303
H. Kranendonk, J. Verbruggen, ‘Is de huizenprijs in Nederland overgewaardeerd?,’ CPB Memorandum (2008)
130
early 1980s. The result of starting the calculation of the “normal” average growth figure over only
this period, is that it actually is the average growth figure of long upward trend that started in the
early 1980s and eventually became a bubble. Taking this average growth figure as the “normal”
growth figure and only regarding anything above this figure as a bubble, makes it clear why the CPB
disregarded the notion of a bubble in the housing prices. With clear opposing views of the IMF, and
other foreign research, it makes me wonder why the CPB did the calculation this way. The factors
behind the house prices changes seem to be calculated in a way that tried to support their assertion
that the strong price rises were not excessive and a bubble (and therefore the possibility of a crash)
was nowhere to be found.
131

14.00%
real houseprice
12.00% index
10.00%
Income
8.00%
Interest
6.00%
4.00%
Leverage
2.00%
0.00% other
-2.00%
After a flat period between 2002 and 2003, the Dutch housing market saw its latest boom
period. Housing prices soared again with almost 12 percent in real terms. Again this boom was
supported mostly by rising leverage levels, as income and interest rates were stagnant. But the
economy was buoyant with over 13 percent growth in real terms over this period and unemployment
reached very low levels of just 3 percent (there was the rising notion that a shortage of labour period
was just around the corner). If there was a mood of optimism it was justly motivated.
132
But consumer confidence was very negative at the beginning of the period and only turned
positive in the second quarter of 2006. On the other hand consumer confidence was in an almost
constant rise, just like housing prices, which is reflected by a strong positive correlation of 0.98. Still
the very negative readings at the first part of the period, while housing prices were already rising,
does result in some doubt about the true relationship between consumer confidence and housing
prices. The expected effect should have showed, as from the reversal in the second quarter of 2008 in
the consumer confidence (especially as these events are generally given a lot of media attention), that
from that moment a clear reaction should have been be visible in housing prices, which did not
happen.

120
100
real
80
houseprice
index
60
40
20
0
consumer
-20 confidence
index
-40
-60
3
3
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
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-Q
-Q
-Q
03
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20
20
133
6.3 Booms & Manias: it is all about the money!

The support for housing market booms changed over time. The booms of the 1970s were supported
by rising income or leverage, preferable economic conditions and other circumstances. During these
early booms the “other” category, was a also strong influence. But during the 1980s, the leverage
parameter became the most important factor pushing housing prices upwards. With reference to the
decline of relationship banking and the lack of appreciation for leverage in the new “standardized
loan assessment” era, the changing structure of the mortgage market seems very important. It also
questions the risk assessment ability of all financial experts involved (from banks, to credit rating
agencies, to regulators). The impact of consumer confidence on rising housing prices seems mixed.
Positive and rising confidence figures were apparent during boom periods but most of the time these
consumer confidence figures were not particularly supportive of the entire duration of the boom.
Especially the Dutch confidence index (that also gives an idea of the number of pessimists versus
optimists) puts doubt about the value that should be given to rising confidence levels. If confidence
levels are very negative, but rising and therefore show a strong correlation, should we ignore the
negative reading and accept the correlation result as proof of support of housing price rises? I would
be careful to make hard conclusions about the impact of consumer confidence on housing prices.
Hereunder I have summarized the findings of chapter 6, which I think are the paramount elements of
this analysis. The main factors of booms and manias:
1) Rising leverage is the main element behind booms since the 1980s and the main reason why
the booms of the 1990s and 2000s in the Dutch and American markets turned into bubbles.
2) If we compare the bubble of the late 1970s in the Dutch housing market with the later
identified bubbles, the analysis showed that bubbles are not only the result of rising leverage.
The Dutch boom of 1975 to 1978 shows that with support of other elements and possibly
behavioural elements (expectations of high inflation, while in reality inflation was swiftly
declining), booms can become bubbles without the overwhelming impact of leverage. In the
Dutch case, the housing shortage might also result in the more pronounced upward pressures
during booms in relation to the American case.
3) High inflation can be seen as high volatility, as explained with the networks perspective in
Chapter 2, and lead to price distortions. This is similar to Robert Shillers feedback loop,
where price changes are intensified by earlier price rises.
134
4) The move away from relationship banking, supported by deregulation, was inherently flawed,
as it did not take leverage into account.
5) Risk assessment by financial experts is lacking and faults in the basic assessment structure
endured these wrong risk assessments. This should be a major reason for regulating the
financial sector, as earlier real estate crashes were founded in the same misinterpretation. For
example, in a reaction of an Australian CEO to an inquiry into the late 1980s banking
problems in Australia, he argued that banks mispriced the risk component, as the banks did
not pay enough attention to the pricing of risk. He replied that this was due to their lack of
experience, as the following quote shows:
‘This was partly because we were on a fairly steep learning curve after the shackles of
regulation were removed. We were also faced with a scramble for market share by new bank
entrants and by state banks which were vigorously – and some may observe disastrously –
trying to turn themselves into commercial banks virtually overnight’ 304
It seems that these banks have not learned since then about how to price risk, as ignoring
leverage seems not only to be a beginners mistake (see for example textbooks about credit
risk assessment 305), but apparently problems with the pricing of risk have endured ever since.
6) Research into international real estate booms (for example by the IMF and the BIS) point
towards the effects of international financial globalisation as to why the booms have
coincided in the late 1990s and early 2000s. Although I do not want to discard their
assessment in any way, I do want to point out that the Dutch and American housing booms
have seen a simultaneous movement at least since the early 1970s, as all booms in this
research occur mostly at the same time. It is therefore not only the latest boom that happened
simultaneous, but the previous ones as well.
304
J. Simon, ‘Three Australian Asset-price Bubbles,’ RBA Working Paper (2003) 32
305
B. Ganguin, J. Bilardello, Fundamentals of Corporate Credit Analysis (New York 2005) 89-90
135
Chapter 7: To Fall Or Not To Fall
Many researchers and commentators argue that bubbles can only by recognised when they pop. This
notion suggests that bubbles are always followed by a crash, but do they? As I have indicated in
Chapter 5, especially the Dutch housing market has seen many flat periods, even after strong rises,
even ones which could be considered to be bubbles. The American housing market has also known a
flat period, but here it came after a bust. Nevertheless it might be interesting to find out under what
circumstances housing markets face a downturn and when they flatten out.
This chapter will present either bust or flat period in a chronological order, just like the
booms in the previous chapter.
7.1 The American market: After a boom comes a bust

Even though many investors believed that the American housing prices could only go up, the
housing market has seen its share of busts. 306 Over the 40 year research period only the first bust is
stronger than its preceding boom, all others have stronger booms than busts, either percentage wise
or in absolute numbers.
The Bust of 1973 to 1975
Figure 45 - American Housing Bust of 1973 to 1975

1.00%
0.00% House Price

Index
-1.00%
-2.00% Income
-3.00%
-4.00%
Interest
-5.00%
Leverage
-6.00%
-7.00%
other
-8.00%
-9.00%
306
The belief that housing prices only go up is almost always correct if you look at nominal prices, a format that housing
price indexes are normally expressed in. Beside labelling such comments as purely irrational, it might also suggest that
people are far more under the influence of “money illusion” than economists dare to admit. Perhaps Post-Keynesians
have a point about the illusion of real prices, while the rest of the world works with nominal prices.
136
The bust of 1973 to 1975 seems strongly related to a negative impact of rising interest rates,
and from declining real income no support was offered as well, while the minimal rising of leverage
had no significant impact. Furthermore the mood in the US, after the collapse of Bretton Woods, a
decline in real GDP and a strongly rising unemployment figure (from 4.8 percent to 8.5 percent)
surely must have had a dampening effect on future expectations, which will have affected the
willingness to do expensive investments like housing.
If we look at other factors in play, unemployment and consumer confidence we get the
picture of Figure 46, below. Please note that the rising unemployment should have had the opposite
effect on housing prices. The unemployment figure is an important figure as the correlation during
busts with real housing prices is almost anytime around negative 0.9, in contrast to the boom periods
where unemployment has a low to very low correlation with housing prices. In this particular bust,
the correlation between real housing prices and unemployment is a negative 0.94, while the
consumer confidence does not show a correlation at all, with a figure of 0.05. Rising interest rates in
combination with rising unemployment seem to have been the main cause behind this bust.
Figure 46 - American Housing Market - Unemployment and Consumer Confidence

190
175 real houseprice

index
160
145
consumer
130 confidence
index
115
100
unemployment
index
85
70
1973 - Q4 1974 - Q1 1974 - Q2 1974 - Q3 1974 - Q4 1975 - Q1 1975 - Q2 1975 - Q3

This bust coincided with the Volcker intervention, where the central bank and its governor Paul
Volcker pushed up interest rates to combat high inflation. Even long term interest rates rose to almost
15 percent in 1981. But the aim of the Federal Reserve was to bring down the consistently high
inflation rates (above 10 percent annually). The rise in interest rates was successful in bringing down
inflation, as it dropped from 15 percent in 1980 to a more normal 4.5 percent (and still declining) at
the end of 1982. These actions brought more down than only inflation, as the economy turned into a
recession and unemployment rose.
137

2.00%
-2.00%
Income
-4.00%
Interest
-6.00%
Leverage
-8.00%
other
-10.00%
-12.00%
The bust in housing prices was affected by many sources as real income declined, interest
rates rose strongly, leverage levels were stagnant and unemployment rose. It should be no surprise
that the consumer confidence also turned very negative during this period, as can be seen in Figure
48.

190
175
real houseprice
index
160
145
130 consumer
confidence index
115
100
unemployment
85 index
70
1979 - Q3 1979 - Q4 1980 - Q1 1980 - Q2 1980 - Q3 1980 - Q4 1981 - Q1 1981 - Q2 1981 - Q3 1981 - Q4 1982 - Q1 1982 - Q2 1982 - Q3 1982 - Q4
The unemployment figures as well as the consumer confidence index both have strong
correlations with real housing prices during this period, unemployment has a negative correlation of -
0.92, and consumer confidence has a positive correlation of 0.91. Considering all these negative
influences, it was to be expected that the housing market would see declining housing prices. If there
is any surprise it is that housing prices did not crash any deeper, the reasons for a deeper crash were
there.
138
The bust of 1989 to 1993 seems more to do with general economic circumstances, with
unemployment rising (from 5.4 to 7.1 percent) and real GDP declining at the beginning of the period
(total growth of real GDP for the period was just three percent). Nominal income was fairly stagnant
and real income declined.

15.00%
House Price
10.00% Index
5.00%
Income
0.00%
Interest
-5.00%
-10.00%
Leverage
-15.00%
other
-20.00%
-25.00%
The reaction of the Federal Reserve, supported by a declining inflation figure, pushed the
interest rate down to revive the economy. The economy did revive during this period, but real
housing prices only reach bottom at the end of this period. Interest rates do not seem to have as
strong a reaction as sometimes supposed by finance theory, as the correlation with housing prices is
weaker than several other parameters, as well as different reactions of housing prices in different
periods (sometimes house prices decline as interest rates rise, sometimes it is the other way around,
but it has also happened that house prices declined as interest rates declined).
139
As the economic recession was only mild the consumer sentiment did not worsen
significantly and after a short dip even started rising. That there is no actual relation between
consumer sentiment and housing prices during this period can also be concluded from the correlation
figure, which showed a negative 0.45. The fact that it shows a negative correlation is enough reason
to dismiss the consumer confidence as influential in this downturn, but that it even shows a relatively
strong negative correlation result only strengthens this observation.
The unemployment rate on the other hand shows the familiar picture. Even though it was
considered to be a mild recession, unemployment rose strongly and a negative correlation of 0.93
seems to confirm that rising unemployment caused the bust in this period.

150
140
real houseprice
index
130
120
consumer
confidence index
110
100
unemployment
index
90
80
1989 - Q4 1990 - Q1 1990 - Q2 1990 - Q3 1990 - Q4 1991 - Q1 1991 - Q2 1991 - Q3 1991 - Q4 1992 - Q1 1992 - Q2 1992 - Q3 1992 - Q4 1993 - Q1
140
The Flat period of 1993 to 1996

Finding an explanation for the flat periods is actually rather difficult. The analysis used in the
previous and current chapter does not really work for the flat periods, as the low impact of income,
interest and leverage is the result of very low correlation figures. In fact the circumstances of 1993 to
1996 were fairly benign.
Figure 51 - American Housing Flat Period of 1993 to 1996

0.50%
House Price
0.40% Index
Income
0.30%
Interest
0.20%
Leverage
0.10%
other
0.00%
-0.10%
The real GDP grew with an overage of 2.6 percent annually during this period, which is a
good figure for a developed country. Other supporting figures were household income that was rising
(real income with 5.4 percent) and unemployment declined (from 7 percent to 5.3 percent). Less
stimulating circumstances were a rising interest level (from 6 percent to 6.8 percent), while leverage
even declined (with only 2 percent, but it is remarkable, because a decline was relatively rare during
the period of research).
141
When we take a look at other factors that might be influential, we find consumer sentiment
rising strongly, while unemployment is clearly declining. But correlations also for these factors with
the housing price index are nearly zero, or non-existent. Maybe the best explanation is that there was
no real downward pressure, while factors pushing prices upward during booms, the ability-to-borrow
factors, were rising strong enough to create a boom.

140
130
real houseprice
index
120
110
consumer
confidence
index
100
90
unemployment
80 index
70
1993 - Q2 1993 - Q3 1993 - Q4 1994 - Q1 1994 - Q2 1994 - Q3 1994 - Q4 1995 - Q1 1995 - Q2 1995 - Q3 1995 - Q4 1996 - Q1 1996 - Q2 1996 - Q3

The bust of 2006 to 2009 looks somewhat similar to the bust of 1989 to 1993. Please note that the
title of this bust might suggest an end to the bust in 2008, I actually do not argue that the American
housing bust is over in that year, just that most of my data series end in 2008. On the other hand it
needs to be said that the decline in real housing prices has stopped at the end of 2009 (quarter-on-
quarter assessment).

30.00%
20.00%
House Price
Index
10.00%
Income
0.00%
-10.00% Interest
-20.00%
Leverage
-30.00%
-40.00% other
-50.00%
-60.00%
142
Just like we have seen during the 1989 to 1993 period above, the Federal Reserve reacted on
the dire economic circumstances with a decline in interest rates, but again this does not seem to have
supported the housing price during this period. Income and leverage were fairly stagnant (real
income dropped with just 2 percent, leverage with 0.15 percent). The most important element seems
to have been unemployment again, which rose from 4.6 to 7 percent (and was still rising).
Historically high leverage levels , FHFA figures indicates average leverage levels of 4.5, which was
up from 2.3 in the seventies, made the housing market fragile in the case of declining housing prices,
as owner-occupiers find themselves in financial trouble sooner, where small problems can lead
quickly to payment problems and therewith to foreclosure. And with high loan-to-value ratio’s it will
be the mortgage owners (banks, among others) who will face problems with declining housing
prices, as they have to take losses on each foreclosed home. But this dire circumstances did not make
the Americans feel pessimistic, as Figure 54 shows, probably because the economy was still
growing. But unemployment was rising, especially at the end of the period, and with a negative
correlation of -0.87 it is still the main parameter that is always present during housing busts.

155
145
real houseprice
index
135
125
115 consumer
confidence
105 index
95
85 unemployment
index
75
65
2006 - Q2 2006 - Q3 2006 - Q4 2007 - Q1 2007 - Q2 2007 - Q3 2007 - Q4 2008 - Q1 2008 - Q2 2008 - Q3 2008 - Q4
143
7.1 The Dutch market: A boom is not necessarily followed by a bust

During the period under research the Dutch housing market has seen two flat periods, two busts, and
one period that is not a real bust, but not a real flat period either. The Dutch housing market clearly
has less downward pressure than the American market. This might be the result of its structural
shortage of housing. If this is the case than flat periods should show downward pressure from many
parameters, without much effect. But it might also be the result of specific parameters that are
positive, with a mixed picture of upward and downward pressure as a result. Anyway, it will be
necessary to review all parameters during the flat periods.
Figure 55 - Dutch Housing Flat Period of 1974 to 1975

0.09%
real
0.08% houseprice
index
0.07%
Income
0.06%
0.05% Interest
0.04%
Leverage
0.03%
0.02%
other
0.01%
0.00%
The period from 1974 to 1975 is a flat period, but that is (at least partly) the result of the
cancelling out of strong nominal prices rises by equally high and rising inflation rates (up to 10%
annually), while interest rates were declining. Real income rose just a bit, but nominal income rose
with an astonishing 21.5 percent during this period. Maybe that is the most important element, the
circumstances were not overwhelmingly good (end of Bretton Woods, first oil crisis just a few years
back), but also not really bad either. Unemployment rose with 110 percent, but from very low levels
(from 2.7 percent to 5.8 percent). Interest rates even declined, but inflation rose, the economy grew
in nominal terms and declined a bit in real terms.
144
Consumer confidence was not supportive, with an average figure of minus 15. Considering
the earlier viewed American busts, all ingredients for busts were apparent, but the market only
flattened out. Perhaps the shortage on the housing market made sure that minor negative economic
parameters were not enough to push housing prices down.
Figure 56 - Dutch Housing Market - Unemployment and Consumer Confidence

250
real houseprice
200
index
150
consumer
100
confidence index
50
unemployment
0
index
-50
1974 - Q1 1974 - Q2 1974 - Q3 1974 - Q4 1975 - Q1 1975 - Q2

In contrast to the flat period of 1974 to 1975, the bust of 1978 to 1985 was really strong and pushed
the real housing prices to levels not seen since the 1950s. With an economy in ruins, mass
unemployment, demonstrations, and the like, the mood of this period was overwhelmingly negative.
The consumer confidence index shows this with one positive figure of 3 points in the fourth quarter
of 1985 and an average of minus 27.3 points over the entire period (versus an average between 1972
and 2009 of minus 9.32 points).
Figure 57 - Dutch Housing Bust of 1978 to 1985

60.00%
real
40.00% houseprice
index
20.00%
Income
0.00%
Interest
-20.00%
-40.00%
Leverage
-60.00%
other
-80.00%
-100.00%
145
Real income declined marginally, but unemployment jumped from 5.7 percent to 9.4 percent.
Interestingly leverage did rise (with a strong rise of nominal total debt of 127 percent and 70 percent
in real terms) very strongly, but this failed to impact the housing prices one bit. The reason for the
bust of the housing market seems mostly due to rising unemployment and other negative economic
prospects, like the second oil crisis, high inflation and declining economic growth from 1980 to
1982. But It needs to be noted that the real economic picture was not that bad, beside the high
unemployment rate of course. Economic growth for example declined from 1978 to the third quarter
of 1982 with just 1.5 percent in real terms and growing with an overall figure of 6 percent from 1982
until the end of 1985. The unemployment seems again to have the strongest impact with a correlation
of minus -0.80 with housing prices over the period. Negative consumer confidence surely did not
help either, but the correlation results only in a positive 0.16.
150
real houseprice
index
125
100
75
consumer
confidence
50 index
25
0
unemployment
index
-25
-50
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4
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146
The Bust/ Flat Period of 1990 and 1991

The 1990 1991 bust is an interesting case. It follows a boom period, but it is not really a bust, but the
decline is strong enough to not call it a flat period either. But what is really special about this bust is
that nothing really seems to have created the bust.
Figure 59 - Dutch Housing Bust / Flat Period of 1990 to 1991

1.00%
real
houseprice
0.50% index
Income
0.00%
-0.50%
Interest
-1.00%
Leverage
-1.50%
-2.00%
other
-2.50%
Real GDP grew (with 3 percent) , real income grew, leverage grew, interest rates were stable,
but declining, inflation was low and stable below 3 percent annually. The only reason for a bust was
the mood, with mild recessions in countries like the United States and Great Britain. If we take a
look at consumer confidence we see that the consumer confidence indeed was declining over this
period and even turned negative in the third quarter of 1990. But this was just the start of a decline,
reaching minus 25 points in 1993, when the boom (see previous chapter) had already started.

120
100 real houseprice

index
80
60
consumer
confidence
index
40
20
unemployment
0 index
-20
1990 - Q1 1990 - Q2 1990 - Q3 1990 - Q4 1991 - Q1 1991 - Q2
147

After the boom period of 1991 to 2001, the housing prices cooled down for a short period. Note that
the scale in Figure 61 ranges only from minus 0.03 percent to 0.01 percent. After the dot.com crash,
the ECB lowered its interest rates (just like the Federal Reserve), but the jubilant experience of the
past 10 years was temporarily hit back, by talk of recession, 9/11 and the popping of the internet
bubble.
Figure 61 - Dutch Housing Flat Period of 2002 to 2003

0.01%
real houseprice
index
0.00%
Income
-0.01%
Interest
-0.01%
-0.02% Leverage
-0.02%
other
-0.03%
Income was, as in the preceding boom period, still stagnant during this period and leverage
even declined with 11 percent (the low results above are due to the low correlations). Turning to the
other factors in play, unemployment did rise, but from extreme lows of just 2.5 percent to a, still very
respectable, 3.6 percent. The consumer confidence index really started to turn negative, continuing
its decline from 2001 to very low levels of minus 36 in 2003 before starting its slow recovery to
positive territory.
148
As with the flat period of 1974 to 1975 all ingredients for a significant downturn seemed to
be present, especially from the very high housing price levels it reached during the bubble period it
succeeded. As with that period, I tend to conclude that the structure of the Dutch housing market
with its persistent shortage of housing in combination with the absence of truly bad economic
parameters (stagnant GDP and still low unemployment figures), made sure that a significant
downturn in housing prices was a situation that did not arise.

160
140 real houseprice

index
120
100
80
60 consumer
confidence
40 index
20
0
unemployment
-20 index
-40
-60
2002 - Q1 2002 - Q2 2002 - Q3 2002 - Q4 2003 - Q1 2003 - Q2

With the economic destruction of 2008 the Dutch housing market saw its first housing bust since the
1980s, although a real crash has still not happened. As with the American case the end of this period
is determined by the absence of continuing data series. The Dutch housing prices continued during
2010, its relatively slow decline in housing prices.
Figure 63 - Dutch Housing Bust of 2007 to 2009

6.00%
real
4.00% houseprice
index
2.00%
Income
0.00%
-2.00%
Interest
-4.00%
-6.00%
Leverage
-8.00%
-10.00%
other
-12.00%
-14.00%
149
While the ECB, again just like the Federal Reserve, started a very loose monetary policy with
very low interest rates, it failed to support the housing prices. Leverage did rise with some 5 percent
and even income rose with 2.5 percent over the period (perhaps due to previous labour agreements).
But unemployment started rising quickly at the end of 2008, while consumer sentiment was
already turning very negative with the consumer confidence index reaching minus 31 points at the
end of 2008. It is still interesting to note that housing prices did not collapse as in the American case,
while the economic conditions deteriorated fast and significantly. So the general view regarding the
Dutch housing market is that it does not easily turn into a crash or even a pronounced downturn.
With reports pointing towards stabilisation of the housing market in 2011, even one of the worst
recessions of the last century did not result in a crash of the Dutch housing market bubble.

140
120
real house price
index
100
80
60
consumer
confidence index
40
20
0
unemployment
index
-20
-40
2007 - Q4 2008 - Q1 2008 - Q2 2008 - Q3 2008 - Q4 2009 - Q1 2009 - Q2 2009 - Q3 2009 - Q4
150
7.2 Housing prices going down: a behavioural puzzle?

Downward pressure on the housing market seems to be the result of two parameters and behavioural
influences. First, rising unemployment shows a strong correlation to housing prices during every
downturn. This relationship is not only a behavioural one (rising unemployment dents expectations
about the economy by potential buyers), but rising unemployment also means a rise in forced selling
of houses. This creates a double price effect, as forced sellers are met with hesitation by potential
buyers. I therefore consider unemployment as the main parameter behind declining housing prices.
Furthermore the Dutch housing market does not seem to crash, even though economic
parameters turn negative. Equal conditions in the American housing market do create declining
housing prices, while the Dutch housing market only stagnates into a flat period. This points towards
structural issues within the Dutch housing market that results in very low downward elasticity of
housing prices. The most probable structural explanation for this phenomenon seems to be the
continuous housing shortage on the Dutch housing market.
Consumer confidence does not present a clear relationship with housing prices during
downturns, although the impact seems far stronger than the more ambiguous effect during boom
periods. The reason for the absence of a clear relationship of the consumer confidence with housing
prices might be due to the index itself. It might be that the consumer mostly reacts to negative stories
in the media, while the actual economic conditions are not that worse. The media tends to be far
more negative than the overall picture justifies. Another element about the weak relationship is in the
compilation of the consumer confidence indexes. Perhaps these indexes do not capture the correct
mood about the economy, but more the reaction of survey applicants towards the media and other
general events. The overwhelming negative mood of the Dutch consumer confidence index does not
find any support within real economic conditions. A broader view of this missing link to reality in
consumer confidence indexes can be found in the book “Irrational Exuberance” by Robert Shiller
(revised second edition, 2005)
151
Conclusion: Where are the regulators?
First you will find a summary and review of the past chapters with some remarks and the main
findings. Answering the thesis question will be next and I end with a final remark.
In the introduction I have addressed two important discussions. The first is a general
discussion about macroeconomic theories and models and the second discussion was about the
effects of asset bubbles, like housing bubbles, on monetary policy and vice-versa. The first
discussion was dissected in different schools of thought (see Chapter One), while the second
discussion will be reviewed in this chapter. The review of the macroeconomic discussion led to the
identification of two main schools of thought with the New Classicists and the New Keynesians.
Based on problems with some basic assumptions of the New Classicists, I pointed towards the
growing acceptance of New Keynesian theories, especially the fact that in many sectors imperfect
markets are the norm and that these markets have their own structure, effects, and price setting
mechanisms. As explained in chapter one this theoretic discussion about how markets work is not
only relevant for researchers at universities. All economic agents, from governments to businesses to
consumers, daily make important decisions, which are at least partly based on their understanding
how the economy works.
It is therefore important to have a broader public discussion about how the market works, but
here we must be careful not to get bogged down in a debate over who should take the lead, the
market or government (this is not a true antithesis anyway). Instead we should consider how to cope
with the market imperfections and its incorporation into the theories and models.
The second chapter addressed the micro-foundations and structure of the housing market
itself, needed to understand all facets of this market, as well as reviewing all existing theories. I have
given a description of how the housing market works, which people and professionals are involved
and how people buy a house and reach a transaction price. I also summed up the many indicators that
might be relevant, which formed the basis for my six quantitative perspectives of my framework, as
explained in chapter four and applied in Part II. This chapter also touched on some existing research
about the structure of the housing market, with an important outcome that the housing market is not
considered to be an efficient housing market in the sense of New Classicists. Other structural
elements were imperfect markets, local network perspective and behavioural aspects. The second
chapter also reviewed some valuation methods, of which some are applied in the empirical section of
Part II. Beside reviewing the elements that are important within the housing market, chapter two also
presented the case for a New Keynesian view of the housing market. The result of this perspective is
152
a market that is less, and certainly not only, driven by supply and demand. It is this conclusion that
has led to arguing that the ability to borrow is one of the main elements driving housing prices.
The third chapter zoomed in unto the existing ideas about asset bubbles, which are not a new
phenomenon of recent history. These bubble theories ranged from (New) Classicists rational bubbles,
credit&asset cycles, new economy bubbles, Minsky-Behavioural Bubbles (a la Robert Shiller) and
pure behavioural determined bubbles. The classicist theory in principle argues that bubbles cannot
exist, but the overwhelming evidence that occasionally price explosions do happen, have pushed
them in formulating a theory of bubbles that would fit their general theoretic framework. As
explained it is doubtful if they have succeeded, as their proposed mechanisms behind bubbles are
either not able to explain the price explosions sufficiently (the unclear fundamentals argument) or the
proposed mechanism is at odds with the general assumption of rational efficient markets of their
general theory (the momentum traders argument). I argue that there are two main explanations for
creating bubbles, which are not exclusive, but complement each other. The role of credit has long
been seen as elementary in asset cycles (already in the 19th century) and based on the presented
bubble theories, also one of the main elements behind bubbles. The other explanation is found within
the economic actors themselves. Economic agents do not necessarily behave in an economic rational
way. As has been shown by the growing field of behavioural economics, people are (unknowingly)
susceptible to otherwise irrational perspectives. So rising housing prices can simply result in the
believe that they will continue rising. Behavioural economics has also shown that people are only
sceptical and performing research to find risks, when they are pessimistic. So different researchers
have devised bubble theories that use either credit or behaviour, but mostly both, to explain the
explosive price bubbles.
Based on the first three chapters, the fourth chapter presented the framework of analyzing the
American and Dutch housing markets. First was explained how to identify a bubble, which is defined
as a situation where actual prices deviate significantly from fundamental prices. But the relation
between fundamentals of housing prices is not very strong and thereby not the ideal way of analyzing
the housing market. Therefore I started with identifying the booms, busts and flat periods of the
housing markets of the two case studies and explained the technicalities behind these identifications.
The broader analysis of the housing market was set out in two ways, one based on long-term trends
and fundamentals and the second way by specific analysis of the booms, busts and flat periods. The
long-term analysis was done through six different perspectives, which relevance in the analysis are
explained in this chapter. Next the mostly quantitative analysis of the specific periods was set out
with the emphasis on a framework named ability-to-borrow (based on income, interest and leverage),
in which monetary policy was considered to be responsible for the impact of interest rates and
153
regulators for the impact of leverage. Two other elements, unemployment and consumer confidence,
were also added, for explaining the downward pressure on the housing market.
Chapter Five set out to present four things of the analysis, starting with presenting the result
of the subdivision of the cycle of both housing markets, from 1970 until 2008, in three periods of
booms, busts and flat periods. Then each housing market was analysed separately, starting with an
introduction of some structural elements related to the financing of the housing market, the taxation
of the housing market and a few other specific characteristics. An important change in the mortgage
origination process is the standardization of the mortgage application process since the 1980s, in
which leverage has not been given due attention. This analysis of the structure is followed by the
main part of chapter five with the long-term analysis of the six perspectives as set out in the previous
chapter. This analysis showed first why the ability-to-borrow framework incorporates the main
driving forces behind the price deviations on the housing market and secondly this analysis showed
the weak relations between the theoretical identified fundamentals and actual house price changes,
with a sobering view on the lack of a meaningful connection between the rental market and the
owners market. Chapter five ends with the quest for bubbles within housing markets. Here income
was identified as the main fundamental parameter behind housing prices and to make an assessment
of the existence of bubbles. The conclusion was that both housing markets have either experienced a
price bubble (the American market) or are still in bubble territory (The Dutch market). In this section
I have also added another view, by using income and an accounting based calculation to come up
with a, from an accounting perspective, sustainable level of housing prices. Also with this accounting
based analysis both housing market has experienced a bubble.
The long-term view of chapter five is complemented by an analysis of the individual periods
of booms (chapter six), busts and flat periods (chapter seven). The framework of ability-to-borrow,
introduced in chapter four, is used to assess the impact of income, interest and leverage on house
prices. The main conclusion of chapter six regarding booms is that leverage has had a growing
impact on housing prices since the 1980s and is the main reason why the booms of the 1990s and
2000s turned into bubbles. This conclusion turns the attention to the flawed mortgage origination
process and the assessment of credit risk performed by all parties involved. Another conclusion is
that the housing prices are not only influenced by different economic parameters, but that the
reaction of the prices to these is different per period. These different price reactions probably makes
standard modelling of the housing market difficult. Although not researched in this thesis, the
different market reactions, might be due to changing behaviour of economic agents over time or
under different circumstances (see chapter one about behavioural economics). The analysis of the
busts and flat periods in chapter seven points towards unemployment as the main factor for
154
downward pressure on the housing market. This might suggest that unemployment influences
consumer confidence and results in hesitation of potential buyers entering the market. But the
relation of consumer confidence during either boom or bust is not as strong and clear cut to make this
assumption. Finally the downward pressure of the used parameters appears to be less strong in the
Dutch housing market in contrast with the American housing market. The result is that booms in the
Dutch housing market are generally followed by a flat period, instead of a significant downturn in
housing prices. The rigidity of Dutch housing prices to downward pressures points towards structural
issues on this market for which the continuous housing shortage is probably the main reason.
Returning to the main thesis question, is deregulation or monetary policy the main reason
behind housing bubbles. The answer must be deregulation. It is clear that deregulation seemed to
have supported the rise in leverage, which in turn was the main reason for the bubbles. The argument
is not that interest levels had no effect, but this was not as strong and consistent as the impact of
leverage. Regulation should have been stronger in relation to the mortgage application process,
where the factor of leverage was ignored (focused on loan-to-value ratios and monthly payments
versus income). If leverage was added to the assessment of credit worthiness of the borrower, rising
leverage would have resulted in a risk premium, lowering the affordability and total borrowing
capacity. Although risk control has become far more sophisticated and complex since the 1980s, but
the wrong risk assessment was embedded in the structure of the mortgage sector, not necessarily in
the quality of risk assessment models with investors or credit rating agencies.
Now I return to the monetary discussion about the role of monetary policy in relation to asset
bubbles. As financing and interest rates play a major part in the housing booms it is necessary for
central banks to acknowledge the existence of asset bubbles and the need to react to the possible
appearance of bubbles. Furthermore the strong link between economic growth and the housing
market, as addressed in the introduction, spells out a need for better policy for the housing market in
general and asset bubbles in particular. Also central banks and other institutions (like statistical
offices and universities), should give more attention to the general macroeconomic theoretical
debate. Most textbooks suggest a comprehensive set of agreed theories, but this is not supported by
current scientific discussions. As the creation of independent central banks was the result of the new
classicists theoretical revolution of the 1980s (due to their promotion of rules-based monetary
policy), these central banks should defend and explain their right to existence based on the current
macroeconomic theories. Not the least to avoid being seen as part of the problem instead of being
part of the solution of a crisis still in progress.
155
I want to add a final remark regarding the construction and reliability of mathematical
modelling and analysis. The strong growth in the use of statistics and mathematical models by either
researchers, regulators and companies, should not be abandoned. These mathematical techniques
have offered new and better insights into the inner-workings of our economy and the implications of
policies and changing market conditions on markets in general of the performance of assets and
companies specifically. But I argue that even the most sophisticated or structurally sound
mathematical models struggle to incorporate the complex structure and inner-workings of markets on
a continuing basis. Therefore I suggest that the best way forward is to add so-called descriptive
scenario analysis to improve our understanding of past, current and future economic events. These
descriptive and mathematical models complement each other and can help the economic science to
make the next step. This would also create a role for behavioural economics within the mainstream
economic sciences.
156
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165
Appendix A – American Historic Data

current prices
1970 = 100 1966 = 100 1970=100 current prices
Consumer Confidence Real Rent Number of Nominal Median Income Percentage
Year Quarter Real Houseprice Index ͣ Index ͨ Index ͩ Real GDP Index ͤ Householdsʰ Households ͥ Unemployment ʲ
1970 Q1 100.00 78.1 100.00 63,401,000 8,734.00 4.17%
1970 Q2 100.78 75.4 99.81 63,745,250 8,807.50 4.77%
1970 Q3 96.78 77.6 99.98 64,089,500 8,881.00 5.17%
1970 Q4 96.85 72.4 99.98 64,433,750 8,954.50 5.83%
1971 Q1 97.34 78.1 101.39 64,778,000 9,028.00 5.93%
1971 Q2 100.17 80.2 102.49 65,252,500 9,195.25 5.90%
1971 Q3 96.57 82.1 103.44 65,727,000 9,362.50 6.03%
1971 Q4 96.66 82.0 105.22 66,201,500 9,529.75 5.93%
1972 Q1 97.39 92.8 106.86 66,676,000 9,697.00 5.77%
1972 Q2 100.64 88.6 108.21 67,069,750 9,900.75 5.70%
1972 Q3 99.45 95.2 109.75 67,463,500 10,104.50 5.57%
1972 Q4 100.26 90.7 111.33 67,857,250 10,308.25 5.37%
1973 Q1 101.48 81.9 113.08 68,251,000 10,512.00 4.93%
1973 Q2 102.96 77.0 113.85 68,653,000 10,683.25 4.93%
1973 Q3 101.03 72.0 114.46 69,055,000 10,854.50 4.80%
1973 Q4 101.32 76.5 114.97 69,457,000 11,025.75 4.77%
1974 Q1 100.79 61.8 113.93 69,859,000 11,197.00 5.13%
1974 Q2 100.40 72.1 113.15 70,174,250 11,347.75 5.20%
1974 Q3 98.40 64.4 112.17 70,489,500 11,498.50 5.63%
1974 Q4 97.12 59.5 111.02 70,804,750 11,649.25 6.60%
1975 Q1 95.40 57.6 111.50 71,120,000 11,800.00 8.27%
1975 Q2 95.86 72.8 112.43 71,556,750 12,021.50 8.87%
1975 Q3 93.37 75.7 112.33 71,993,500 12,243.00 8.47%
1975 Q4 93.27 75.6 113.24 72,430,250 12,464.50 8.30%
1976 Q1 94.10 84.6 115.16 72,867,000 12,686.00 7.73%
1976 Q2 95.83 83.3 116.95 73,185,750 12,907.50 7.57%
1976 Q3 95.08 89.7 118.23 73,504,500 13,129.00 7.73%
1976 Q4 95.87 87.0 120.08 73,823,250 13,350.50 7.77%
1977 Q1 97.14 87.1 121.00 74,142,000 13,572.00 7.50%
1977 Q2 98.88 90.2 121.73 74,614,000 13,945.00 7.13%
1977 Q3 100.20 89.0 123.44 75,086,000 14,318.00 6.90%
1977 Q4 102.43 84.4 125.31 75,558,000 14,691.00 6.67%
1978 Q1 104.67 83.7 126.85 76,030,000 15,064.00 6.33%
1978 Q2 106.14 84.3 127.64 76,355,000 15,413.25 6.00%
1978 Q3 107.52 78.8 128.50 76,680,000 15,762.50 6.03%
1978 Q4 108.72 81.6 129.83 77,005,000 16,111.75 5.90%
1979 Q1 111.15 82.9 130.33 77,330,000 16,461.00 5.87%
1979 Q2 111.35 80.0 129.48 78,191,500 16,773.25 5.70%
1979 Q3 110.80 82.4 128.89 79,053,000 17,085.50 5.87%
1979 Q4 110.05 78.4 128.74 79,914,500 17,397.75 5.97%
1980 Q1 108.93 80.4 126.63 80,776,000 17,710.00 6.30%
1980 Q2 107.46 79.3 124.68 81,174,000 18,051.00 7.33%
1980 Q3 108.38 75.0 125.02 81,572,000 18,392.00 7.67%
1980 Q4 106.04 66.1 124.42 81,970,000 18,733.00 7.40%
1981 Q1 104.15 72.1 124.88 82,368,000 19,074.00 7.43%
1981 Q2 104.17 73.9 125.53 82,657,750 19,348.25 7.40%
1981 Q3 103.36 68.4 125.64 82,947,500 19,622.50 7.40%
1981 Q4 101.93 66.0 127.42 83,237,250 19,896.75 8.23%
1982 Q1 101.90 68.1 127.61 83,527,000 20,171.00 8.83%
1982 Q2 101.18 65.8 126.87 83,624,750 20,349.50 9.43%
1982 Q3 99.06 60.4 126.00 83,722,500 20,528.00 9.90%
1982 Q4 98.60 64.5 126.92 83,820,250 20,706.50 10.67%
1983 Q1 99.90 66.7 100.90 129.29 83,918,000 20,885.00 10.37%
1983 Q2 99.86 62.1 101.90 130.60 84,261,000 21,267.50 10.13%
1983 Q3 99.58 63.3 103.00 131.70 84,604,000 21,650.00 9.37%
1983 Q4 99.00 61.0 104.20 133.37 84,947,000 22,032.50 8.53%
1984 Q1 99.15 67.0 105.10 135.51 85,290,000 22,415.00 7.87%
1984 Q2 99.86 66.9 106.50 137.70 85,664,750 22,715.75 7.43%
1984 Q3 100.00 56.5 108.10 139.81 86,039,500 23,016.50 7.43%
1984 Q4 100.19 52.7 109.40 142.55 86,414,250 23,317.25 7.30%
1985 Q1 100.70 51.7 110.70 144.10 86,789,000 23,618.00 7.23%
1985 Q2 101.39 58.7 112.50 144.97 87,206,250 23,937.75 7.30%
1985 Q3 102.49 62.3 114.30 146.39 87,623,500 24,257.50 7.20%
1985 Q4 102.75 67.3 115.90 148.00 88,040,750 24,577.25 7.03%
1986 Q1 104.12 73.7 117.00 149.73 88,458,000 24,897.00 7.03%
1986 Q2 106.85 75.0 118.90 151.20 88,713,250 25,188.00 7.17%
1986 Q3 108.01 76.7 119.90 152.88 88,968,500 25,479.00 6.97%
1986 Q4 109.04 64.5 121.50 154.20 89,223,750 25,770.00 6.83%
1987 Q1 110.01 71.4 122.50 154.88 89,479,000 26,061.00 6.60%
1987 Q2 112.52 66.9 124.10 155.14 89,890,250 26,352.00 6.27%
1987 Q3 113.62 66.5 125.40 155.60 90,301,500 26,643.00 6.00%
1987 Q4 114.16 72.4 127.50 156.73 90,712,750 26,934.00 5.83%
1988 Q1 114.21 76.3 129.00 158.67 91,124,000 27,225.00 5.70%
1988 Q2 117.45 73.1 130.00 159.58 91,550,500 27,645.25 5.47%
1988 Q3 118.27 74.1 131.90 160.52 91,977,000 28,065.50 5.47%
1988 Q4 118.37 77.2 133.90 161.84 92,403,500 28,485.75 5.33%
1989 Q1 119.22 73.1 134.80 162.95 92,830,000 28,906.00 5.20%
1989 Q2 120.64 70.3 136.30 163.30 92,959,250 29,165.25 5.23%
1989 Q3 121.07 62.5 138.20 164.89 93,088,500 29,424.50 5.23%
1989 Q4 120.27 64.3 140.50 166.22 93,217,750 29,683.75 5.37%
a www.irrationalexuberance.com; website linked to the book by Robert Shiller “Irrational Exuberance”
c University of Michigan Consumer Index – www.fed.org
d http://data.bls.gov/cgi-bin/srgate
e www.oecd.org
h US census bureau
i US census bureau
j www.oecd.org
166
current prices
1970 = 100 1966 = 100 1970=100 current prices
Consumer Confidence Real Rent Number of Nominal Median Income Percentage

Year Quarter Real Houseprice Index ͣ Index ͨ Index ͩ Real GDP Index ͤ Householdsʰ Households ͥ Unemployment ʲ
1990 Q1 118.70 71.0 141.10 165.85 93,347,000 29,943.00 5.30%
1990 Q2 118.94 66.5 143.20 166.44 93,588,250 29,988.75 5.33%
1990 Q3 116.07 62.0 146.70 165.97 93,829,500 30,034.50 5.70%
1990 Q4 112.35 65.5 147.50 165.59 94,070,750 30,080.25 6.13%
1991 Q1 110.00 67.5 148.50 165.65 94,312,000 30,126.00 6.60%
1991 Q2 111.49 65.7 149.40 166.03 94,651,250 30,253.50 6.83%
1991 Q3 111.43 65.4 150.90 166.04 94,990,500 30,381.00 6.87%
1991 Q4 109.88 65.4 152.90 166.05 95,329,750 30,508.50 7.10%
1992 Q1 108.74 69.3 153.70 167.31 95,669,000 30,636.00 7.37%
1992 Q2 109.75 73.4 154.60 168.36 95,858,250 30,787.25 7.60%
1992 Q3 108.96 72.1 156.10 169.43 96,047,500 30,938.50 7.63%
1992 Q4 107.14 71.9 157.50 170.60 96,236,750 31,089.75 7.37%
1993 Q1 106.20 70.4 158.80 171.33 96,426,000 31,241.00 7.13%
1993 Q2 106.91 74.6 159.70 172.23 96,596,250 31,496.75 7.07%
1993 Q3 107.27 80.8 161.10 173.68 96,766,500 31,752.50 6.80%
1993 Q4 106.35 89.1 162.30 174.53 96,936,750 32,008.25 6.63%
1994 Q1 106.82 93.3 164.00 176.10 97,107,000 32,264.00 6.57%
1994 Q2 108.49 92.2 164.80 177.70 97,577,750 32,717.00 6.20%
1994 Q3 107.87 92.8 166.40 178.76 98,048,500 33,170.00 6.00%
1994 Q4 106.91 90.9 168.20 180.71 98,519,250 33,623.00 5.63%
1995 Q1 106.06 89.9 169.10 181.28 98,990,000 34,076.00 5.47%
1995 Q2 107.34 89.3 170.30 181.78 99,149,250 34,430.00 5.67%
1995 Q3 107.63 91.1 171.90 183.08 99,308,500 34,784.00 5.67%
1995 Q4 106.68 94.2 173.90 184.23 99,467,750 35,138.00 5.57%
1996 Q1 105.97 100.1 175.00 185.15 99,627,000 35,492.00 5.53%
1996 Q2 107.06 97.4 175.90 185.95 99,974,750 35,870.25 5.50%
1996 Q3 107.29 101.0 177.30 187.53 100,322,500 36,248.50 5.27%
1996 Q4 105.73 96.1 178.90 188.76 100,670,250 36,626.75 5.33%
1997 Q1 106.00 98.1 179.90 190.41 101,018,000 37,005.00 5.23%
1997 Q2 108.00 95.5 180.90 192.56 101,395,500 37,475.00 5.00%
1997 Q3 108.55 96.6 182.60 194.82 101,773,000 37,945.00 4.87%
1997 Q4 108.56 99.1 184.20 197.01 102,150,500 38,415.00 4.67%
1998 Q1 109.57 100.9 185.50 199.12 102,528,000 38,885.00 4.63%
1998 Q2 112.56 96.3 186.80 200.68 102,864,500 39,337.75 4.40%
1998 Q3 114.33 95.7 188.50 202.58 103,201,000 39,790.50 4.53%
1998 Q4 114.76 92.9 190.30 204.70 103,537,500 40,243.25 4.43%
1999 Q1 115.93 96.0 191.30 207.14 103,874,000 40,696.00 4.30%
1999 Q2 118.45 93.7 192.20 208.30 104,081,750 41,019.50 4.27%
1999 Q3 120.38 93.7 193.40 210.13 104,289,500 41,343.00 4.23%
1999 Q4 121.06 94.6 194.90 212.17 104,497,250 41,666.50 4.07%
2000 Q1 122.02 91.8 196.60 213.42 104,705,000 41,990.00 4.03%
2000 Q2 125.68 96.5 197.60 214.48 105,581,000 42,049.50 3.93%
2000 Q3 127.62 94.0 199.20 216.10 106,457,000 42,109.00 4.00%
2000 Q4 128.61 92.4 201.20 218.31 107,333,000 42,168.50 3.90%
2001 Q1 129.01 92.1 202.90 218.00 108,209,000 42,228.00 4.23%
2001 Q2 132.14 88.4 204.90 218.28 108,481,000 42,273.25 4.40%
2001 Q3 135.07 90.9 207.30 219.45 108,753,000 42,318.50 4.83%
2001 Q4 136.08 93.9 210.10 220.94 109,025,000 42,363.75 5.50%
2002 Q1 137.66 95.6 212.20 222.01 109,297,000 42,409.00 5.70%
2002 Q2 141.52 95.9 213.70 222.04 109,792,250 42,636.25 5.83%
2002 Q3 145.27 95.1 215.40 223.06 110,287,500 42,863.50 5.73%
2002 Q4 147.20 96.2 217.30 224.31 110,782,750 43,090.75 5.87%
2003 Q1 148.03 94.8 218.70 224.79 111,278,000 43,318.00 5.87%
2003 Q2 152.14 99.3 219.10 226.08 111,458,500 43,572.00 6.13%
2003 Q3 155.99 97.7 220.10 228.05 111,639,000 43,826.00 6.13%
2003 Q4 159.96 94.9 221.90 230.05 111,819,500 44,080.00 5.83%
2004 Q1 163.03 91.9 222.90 232.00 112,000,000 44,334.00 5.70%
2004 Q2 168.78 95.6 224.30 232.44 112,335,750 44,832.00 5.60%
2004 Q3 174.04 91.4 225.70 235.16 112,671,500 45,330.00 5.43%
2004 Q4 177.47 89.1 226.80 237.67 113,007,250 45,828.00 5.43%
2005 Q1 183.28 90.4 228.40 239.65 113,343,000 46,326.00 5.30%
2005 Q2 189.64 90.2 229.40 240.43 113,603,250 46,794.75 5.10%
2005 Q3 193.91 90.8 230.70 241.97 113,863,500 47,263.50 4.97%
2005 Q4 196.38 92.8 232.20 243.38 114,123,750 47,732.25 4.97%
2006 Q1 197.18 91.1 234.10 245.77 114,384,000 48,201.00 4.73%
2006 Q2 196.11 91.5 236.90 246.42 114,790,750 48,709.00 4.63%
2006 Q3 192.68 93.7 239.70 249.31 115,197,500 49,217.00 4.63%
2006 Q4 191.98 94.4 242.10 251.82 115,604,250 49,725.00 4.43%
2007 Q1 188.32 93.6 244.02 253.48 116,011,000 50,233.00 4.50%
2007 Q2 184.52 89.3 245.24 252.61 116,204,000 50,876.33 4.50%
2007 Q3 180.08 83.1 246.82 254.64 116,397,000 51,519.67 4.63%
2007 Q4 168.44 86.8 248.88 256.28 116,590,000 52,163.00 4.80%
2008 Q1 155.52 90.8 250.48 255.00 116,783,000 51,698.00 4.97%
2008 Q2 150.43 91.6 251.58 252.00 116,882,500 51,233.00 5.30%
2008 Q3 142.87 94.6 252.96 250.30 116,982,000 50,768.00 6.03%
2008 Q4 135.38 91.2 254.67 257.39 117,081,500 50,303.00 6.97%
167
1970 = 100 current prices current prices

Nominal Building Nominal Median Sale Price Nominal Median Sales Price Short Term Interest Long Term total residential mortgage debt Change in
Year Quarter Costs Index ͫ New Homesⁿ Exisiting Homes ͦ Housing Stockʳ Rateˢ Interest Rate ͭ outstanding ͧ CPI ͮ
1970 Q1 100 23,400.00 26,492.10 70,138,000 8.57% 7.37% 469,246,000,000 100.00
1970 Q2 103 23,850.00 27,033.42 70,623,917 7.88% 7.71% 481,389,250,000 98.39
1970 Q3 107 24,300.00 26,229.64 71,109,833 6.70% 7.46% 493,532,500,000 94.23
1970 Q4 110 24,750.00 26,574.11 71,595,750 5.57% 6.85% 505,675,750,000 90.03
1971 Q1 113 25,200.00 26,902.19 72,081,667 3.86% 6.02% 517,819,000,000 75.21
1971 Q2 116 25,800.00 28,140.67 72,567,583 4.56% 6.25% 535,795,250,000 66.14
1971 Q3 119 26,400.00 27,328.69 73,053,500 5.47% 6.48% 553,771,500,000 65.37
1971 Q4 122 27,000.00 27,418.91 73,539,417 4.75% 5.89% 571,747,750,000 49.03
1972 Q1 125 27,600.00 27,886.42 74,025,333 3.54% 6.03% 589,724,000,000 51.27
1972 Q2 128 28,825.00 29,010.07 74,511,250 4.30% 6.14% 608,912,750,000 53.31
1972 Q3 131 30,050.00 28,870.64 74,997,167 4.74% 6.29% 628,101,500,000 50.21
1972 Q4 133 31,275.00 29,436.57 75,483,083 5.14% 6.37% 647,290,250,000 60.05
1973 Q1 136 32,500.00 30,199.35 75,969,000 6.54% 6.60% 666,479,000,000 67.03
1973 Q2 138 33,350.00 31,454.24 76,377,000 7.82% 6.81% 681,950,250,000 83.48
1973 Q3 140 34,200.00 31,757.71 76,785,000 10.56% 7.21% 697,421,500,000 104.60
1973 Q4 142 35,050.00 32,323.64 77,193,000 10.00% 6.75% 712,892,750,000 127.74
1974 Q1 144 35,900.00 33,168.43 77,601,000 9.32% 7.05% 728,364,000,000 157.14
1974 Q2 147 36,750.00 34,054.24 77,972,500 11.25% 7.54% 742,650,250,000 167.87
1974 Q3 150 37,600.00 34,382.31 78,344,000 12.09% 7.96% 756,936,500,000 180.18
1974 Q4 153 38,450.00 34,923.64 78,715,500 9.35% 7.67% 771,222,750,000 193.92
1975 Q1 156 39,300.00 34,890.83 79,087,000 6.30% 7.54% 785,509,000,000 173.16
1975 Q2 160 40,525.00 35,503.15 79,535,500 5.42% 8.05% 806,746,250,000 149.56
1975 Q3 163 41,750.00 35,417.31 79,984,000 6.16% 8.30% 827,983,500,000 139.14
1975 Q4 167 42,975.00 35,943.79 80,432,500 5.41% 8.06% 849,220,750,000 111.11
1976 Q1 170 44,200.00 36,636.23 80,881,000 4.83% 7.75% 870,458,000,000 99.43
1976 Q2 174 45,350.00 37,752.14 81,265,750 5.20% 7.77% 902,635,750,000 96.17
1976 Q3 178 46,500.00 38,101.22 81,650,500 5.28% 7.73% 934,813,500,000 84.59
1976 Q4 181 47,650.00 38,799.38 82,035,250 4.87% 7.19% 966,991,250,000 79.68
1977 Q1 185 48,800.00 40,081.25 82,420,000 4.66% 7.35% 999,169,000,000 93.52
1977 Q2 189 50,525.00 41,580.57 82,969,500 5.16% 7.37% 1,037,033,250,000 108.75
1977 Q3 193 52,250.00 42,730.82 83,519,000 5.82% 7.36% 1,074,897,500,000 103.45
1977 Q4 196 53,975.00 44,087.08 84,068,500 6.51% 7.60% 1,112,761,750,000 104.06
1978 Q1 200 55,700.00 45,489.12 84,618,000 6.76% 8.01% 1,150,626,000,000 102.11
1978 Q2 205 57,500.00 47,131.52 85,057,000 7.28% 8.32% 1,192,214,750,000 108.49
1978 Q3 209 59,300.00 48,579.34 85,496,000 8.10% 8.49% 1,233,803,500,000 127.19
1978 Q4 213 61,100.00 50,090.11 85,935,000 9.58% 8.82% 1,275,392,250,000 142.26
1979 Q1 218 62,900.00 52,356.27 86,374,000 10.07% 9.11% 1,316,981,000,000 152.76
1979 Q2 221 63,325.00 53,832.71 86,882,887 10.18% 9.11% 1,352,182,750,000 169.67
1979 Q3 225 63,750.00 55,017.29 87,391,775 10.95% 9.10% 1,387,384,500,000 184.24
1979 Q4 229 64,175.00 56,035.92 87,900,662 13.58% 10.45% 1,422,586,250,000 198.70
1980 Q1 232 64,600.00 57,226.22 88,409,549 15.05% 11.99% 1,457,788,000,000 223.64
1980 Q2 237 65,675.00 57,855.71 89,047,492 12.69% 10.48% 1,488,206,750,000 227.56
1980 Q3 242 66,750.00 59,732.73 89,685,436 9.84% 10.95% 1,518,625,500,000 202.32
1980 Q4 246 67,825.00 59,881.52 90,323,379 15.85% 12.42% 1,549,044,250,000 197.94
1981 Q1 251 68,900.00 60,499.56 90,961,322 16.57% 12.96% 1,579,463,000,000 176.33
1981 Q2 255 69,000.00 61,598.31 91,209,054 17.78% 13.75% 1,599,912,750,000 153.77
1981 Q3 259 69,100.00 62,359.41 91,456,785 17.58% 14.85% 1,620,362,500,000 170.65
1981 Q4 263 69,200.00 62,605.49 91,704,517 13.59% 14.09% 1,640,812,250,000 149.49
1982 Q1 267 69,300.00 63,372.32 91,952,248 14.23% 14.29% 1,661,262,000,000 120.07
1982 Q2 272 70,800.00 63,595.50 92,333,718 14.51% 13.93% 1,708,568,500,000 107.04
1982 Q3 276 72,300.00 63,337.98 92,715,189 11.01% 13.12% 1,755,875,000,000 88.59
1982 Q4 281 73,800.00 63,738.57 93,096,659 9.29% 10.67% 1,803,181,500,000 69.89
1983 Q1 285 75,300.00 64,986.10 93,478,129 8.65% 10.56% 1,850,488,000,000 59.56
1983 Q2 286 76,450.00 65,701.43 93,890,105 8.80% 10.54% 1,910,747,750,000 51.17
1983 Q3 287 77,600.00 66,147.79 94,302,081 9.46% 11.63% 1,971,007,500,000 44.03
1983 Q4 288 78,750.00 66,393.86 94,714,057 9.43% 11.69% 2,031,267,250,000 53.32
1984 Q1 289 79,900.00 67,412.49 95,126,033 9.69% 11.94% 2,091,527,000,000 67.82
1984 Q2 289 81,000.00 68,505.51 95,542,646 10.56% 13.20% 2,160,629,000,000 68.14
1984 Q3 290 82,100.00 69,135.00 95,959,259 11.39% 12.87% 2,229,731,000,000 66.28
1984 Q4 290 83,200.00 69,861.77 96,375,871 9.27% 11.74% 2,298,833,000,000 63.71
1985 Q1 290 84,300.00 70,834.62 96,792,484 8.48% 11.58% 2,367,935,000,000 57.02
1985 Q2 292 86,225.00 71,939.08 97,211,370 7.92% 10.81% 2,439,866,000,000 58.38
1985 Q3 294 88,150.00 73,186.62 97,630,256 7.90% 10.34% 2,511,797,000,000 52.84
1985 Q4 295 90,075.00 74,079.35 98,049,142 8.10% 9.76% 2,583,728,000,000 52.48
1986 Q1 297 92,000.00 75,447.05 98,468,028 7.83% 8.56% 2,655,659,000,000 45.37
1986 Q2 299 95,125.00 77,026.50 98,838,819 6.92% 7.60% 2,730,890,250,000 33.39
1986 Q3 300 98,250.00 78,302.64 99,209,610 6.21% 7.31% 2,806,121,500,000 25.56
1986 Q4 302 101,375.00 79,561.62 99,580,400 6.27% 7.26% 2,881,352,750,000 23.51
1987 Q1 304 104,500.00 81,192.56 99,951,191 6.22% 7.19% 2,956,584,000,000 36.59
1987 Q2 306 106,500.00 83,888.95 100,293,419 6.65% 8.34% 3,036,023,250,000 51.38
1987 Q3 307 108,500.00 85,498.92 100,635,647 6.84% 8.88% 3,115,462,500,000 66.14
1987 Q4 309 110,500.00 86,624.60 100,977,875 6.92% 9.12% 3,194,901,750,000 70.42
1988 Q1 311 112,500.00 87,265.97 101,320,103 6.66% 8.42% 3,274,341,000,000 63.26
1988 Q2 312 114,375.00 90,669.18 101,555,997 7.16% 8.91% 3,341,919,000,000 62.42
1988 Q3 313 116,250.00 92,279.15 101,791,891 7.98% 9.10% 3,409,497,000,000 63.46
1988 Q4 314 118,125.00 93,221.58 102,027,784 8.47% 8.96% 3,477,075,000,000 67.40
1989 Q1 315 120,000.00 94,805.38 102,263,678 9.44% 9.21% 3,544,653,000,000 75.80
1989 Q2 317 120,725.00 97,383.96 102,603,935 9.73% 8.77% 3,608,486,000,000 80.92
1989 Q3 319 121,450.00 98,457.27 102,944,193 9.08% 8.11% 3,672,319,000,000 73.89
1989 Q4 321 122,175.00 98,653.61 103,284,450 8.61% 7.91% 3,736,152,000,000 73.13
m www.irrationalexuberance.com
n US census bureau
o US census bureau
r US census bureau
s www.oecd.org
t www.oecd.org
u www.fed.org
168
1970 = 100 current prices current prices

Nominal Building Costs Nominal Median Sale Price Nominal Median Sales Price Short Term Long Term total residential mortgage debt Change in
Year Quarter Index ͫ New Homesⁿ Exisiting Homes ͦ Housing Stockʳ Interest Rateˢ Interest Rate ͭ outstanding ͧ CPI ͮ
1990 Q1 323 122,900.00 98,928.49 103,624,707 8.25% 8.42% 3,799,985,000,000 81.56
1990 Q2 325 122,175.00 100,027.98 103,844,668 8.24% 8.68% 3,837,466,250,000 72.82
1990 Q3 326 121,450.00 99,268.81 104,064,629 8.16% 8.70% 3,874,947,500,000 86.98
1990 Q4 328 120,725.00 97,632.65 104,284,590 7.74% 8.40% 3,912,428,750,000 97.50
1991 Q1 329 120,000.00 96,114.30 104,504,551 6.43% 8.02% 3,949,910,000,000 83.13
1991 Q2 332 120,375.00 97,842.08 104,758,181 5.86% 8.13% 3,977,282,250,000 75.13
1991 Q3 334 120,750.00 98,378.74 105,011,811 5.64% 7.94% 4,004,654,500,000 60.65
1991 Q4 337 121,125.00 97,711.19 105,265,441 4.82% 7.35% 4,032,026,750,000 47.43
1992 Q1 339 121,500.00 97,253.06 105,519,071 4.02% 7.30% 4,059,399,000,000 45.55
1992 Q2 344 122,750.00 98,797.59 105,836,188 3.77% 7.38% 4,092,630,500,000 49.06
1992 Q3 349 124,000.00 98,692.88 106,153,304 3.26% 6.62% 4,125,862,000,000 48.66
1992 Q4 354 125,250.00 97,828.99 106,470,421 3.04% 6.74% 4,159,093,500,000 47.53
1993 Q1 358 126,500.00 97,462.49 106,787,537 3.04% 6.28% 4,192,325,000,000 50.17
1993 Q2 362 127,375.00 98,797.59 107,140,870 3.00% 5.99% 4,234,238,500,000 49.04
1993 Q3 365 128,250.00 99,556.77 107,494,202 3.06% 5.62% 4,276,152,000,000 42.84
1993 Q4 369 129,125.00 99,360.43 107,847,535 2.99% 5.61% 4,318,065,500,000 43.25
1994 Q1 372 130,000.00 100,080.34 108,200,867 3.21% 6.07% 4,359,979,000,000 40.04
1994 Q2 372 130,975.00 102,174.62 108,548,907 3.94% 7.08% 4,406,739,250,000 38.33
1994 Q3 372 131,950.00 102,397.14 108,896,947 4.49% 7.33% 4,453,499,500,000 46.66
1994 Q4 372 132,925.00 101,952.10 109,244,987 5.17% 7.84% 4,500,259,750,000 41.39
1995 Q1 372 133,900.00 101,755.76 109,593,027 5.81% 7.48% 4,547,020,000,000 44.62
1995 Q2 375 135,425.00 103,771.51 109,951,476 6.02% 6.62% 4,614,425,750,000 48.50
1995 Q3 378 136,950.00 104,543.77 110,309,925 5.80% 6.32% 4,681,831,500,000 40.50
1995 Q4 380 138,475.00 104,072.56 110,668,373 5.72% 5.89% 4,749,237,250,000 41.70
1996 Q1 383 140,000.00 104,203.45 111,026,822 5.36% 5.91% 4,816,643,000,000 42.71
1996 Q2 388 141,500.00 106,166.84 111,394,867 5.24% 6.72% 4,895,074,500,000 44.36
1996 Q3 393 143,000.00 106,965.28 111,762,911 5.31% 6.78% 4,973,506,000,000 46.18
1996 Q4 398 144,500.00 106,258.46 112,130,956 5.28% 6.34% 5,051,937,500,000 49.94
1997 Q1 402 146,000.00 107,096.17 112,499,000 5.28% 6.56% 5,130,369,000,000 46.20
1997 Q2 403 147,625.00 109,360.61 113,187,500 5.52% 6.70% 5,252,111,500,000 37.26
1997 Q3 404 149,250.00 110,433.93 113,876,000 5.53% 6.24% 5,373,854,000,000 34.46
1997 Q4 405 150,875.00 110,996.77 114,564,500 5.51% 5.91% 5,495,596,500,000 29.04
1998 Q1 406 152,500.00 112,187.89 115,253,000 5.52% 5.59% 5,617,339,000,000 23.08
1998 Q2 408 154,625.00 115,578.00 115,415,910 5.50% 5.60% 5,769,986,000,000 25.54
1998 Q3 410 156,750.00 117,934.07 115,578,821 5.53% 5.20% 5,922,633,000,000 26.08
1998 Q4 411 158,875.00 118,863.40 115,741,731 4.86% 4.67% 6,075,280,000,000 24.71
1999 Q1 413 161,000.00 120,525.73 115,904,641 4.73% 4.98% 6,227,927,000,000 25.91
1999 Q2 416 163,000.00 124,020.56 116,002,297 4.75% 5.54% 6,368,299,250,000 32.67
1999 Q3 418 165,000.00 127,004.91 116,099,954 5.09% 5.88% 6,508,671,500,000 36.92
1999 Q4 421 167,000.00 128,654.15 116,197,610 5.31% 6.14% 6,649,043,750,000 41.17
2000 Q1 423 169,000.00 130,892.41 116,295,266 5.68% 6.48% 6,789,416,000,000 50.97
2000 Q2 424 170,550.00 135,827.06 116,688,386 6.27% 6.18% 6,966,524,750,000 52.32
2000 Q3 425 172,100.00 139,177.90 117,081,506 6.52% 5.89% 7,143,633,500,000 54.42
2000 Q4 426 173,650.00 141,232.91 117,474,625 6.47% 5.57% 7,320,742,250,000 53.50
2001 Q1 428 175,200.00 143,026.14 117,867,745 5.59% 5.05% 7,497,851,000,000 53.59
2001 Q2 429 178,300.00 147,502.66 118,247,486 4.33% 5.27% 7,723,307,500,000 47.66
2001 Q3 430 181,400.00 151,180.74 118,627,227 3.50% 4.98% 7,948,764,000,000 39.60
2001 Q4 432 184,500.00 152,136.25 119,006,968 2.13% 4.77% 8,174,220,500,000 33.51
2002 Q1 433 187,600.00 154,453.05 119,386,709 1.73% 5.08% 8,399,677,000,000 23.87
2002 Q2 435 189,450.00 160,002.89 119,784,399 1.75% 5.10% 8,649,546,750,000 26.02
2002 Q3 438 191,300.00 165,094.60 120,182,088 1.74% 4.26% 8,899,416,500,000 27.67
2002 Q4 440 193,150.00 168,301.47 120,579,778 1.44% 4.01% 9,149,286,250,000 29.93
2003 Q1 442 195,000.00 170,788.42 120,977,467 1.25% 3.92% 9,399,156,000,000 39.00
2003 Q2 450 201,500.00 175,657.62 121,404,549 1.25% 3.62% 9,715,929,500,000 34.69
2003 Q3 459 208,000.00 181,168.19 121,831,631 1.02% 4.23% 10,032,703,000,000 32.86
2003 Q4 468 214,500.00 186,246.82 122,258,712 1.00% 4.29% 10,349,476,500,000 32.76
2004 Q1 477 221,000.00 191,443.24 122,685,794 1.00% 4.02% 10,666,250,000,000 29.66
2004 Q2 483 225,975.00 200,160.68 123,148,995 1.01% 4.60% 11,026,640,250,000 42.85
2004 Q3 490 230,950.00 207,503.74 123,612,196 1.43% 4.30% 11,387,030,500,000 44.95
2004 Q4 496 235,925.00 213,433.17 124,075,397 1.95% 4.17% 11,747,420,750,000 48.69
2005 Q1 503 240,900.00 221,456.88 124,538,598 2.47% 4.30% 12,107,811,000,000 48.88
2005 Q2 508 242,300.00 231,286.90 124,983,023 2.94% 4.16% 12,452,952,750,000 46.58
2005 Q3 513 243,700.00 239,637.83 125,427,448 3.46% 4.21% 12,798,094,500,000 55.02
2005 Q4 518 245,100.00 244,729.55 125,871,873 3.98% 4.49% 13,143,236,250,000 62.79
2006 Q1 523 246,500.00 246,941.63 126,316,298 4.46% 4.57% 13,488,378,000,000 58.60
2006 Q2 526 246,850.00 248,603.96 126,718,190 4.91% 5.07% 13,756,894,750,000 57.87
2006 Q3 530 247,200.00 246,221.72 127,120,082 5.25% 4.90% 14,025,411,500,000 47.43
2006 Q4 533 247,550.00 244,035.82 127,521,974 5.25% 4.63% 14,293,928,250,000 38.71
2007 Q1 536 247,900.00 241,928.45 127,923,866 5.26% 4.68% 14,562,445,000,000 40.06
2007 Q2 547 243,950.00 239,755.63 128,209,216 5.25% 4.85% 14,581,808,250,000 46.17
2007 Q3 570 240,000.00 235,619.43 128,494,565 5.07% 4.73% 14,601,171,500,000 48.57
2007 Q4 236,050.00 223,328.64 128,779,915 4.50% 4.26% 14,620,534,750,000 50.87
2008 Q1 232,100.00 208,694.87 129,065,264 3.18% 3.66% 14,639,898,000,000 60.09
2008 Q2 227,975.00 204,205.26 129,115,264 2.09% 3.89% 14,619,061,559,756 64.08
2008 Q3 223,850.00 197,019.26 129,165,264 1.94% 3.86% 14,533,670,665,739 78.52
2008 Q4 219,725.00 182,450.94 129,215,264 0.51% 3.25% 14,465,096,697,334 33.66
169
Appendix B – Dutch Historic Data

1970 = 100 1970=100 current prices
Consumer Real Rent current prices Number of Nominal Median Income Percentage
Year Quarter Real Houseprice Index ͣ Confidence ͨ Index ͩ Real GDP Index ͤ Householdsʰ Households ͥ Unemployment ʲ
1970 Q1 100.00 20.52 100 3,986,000 5,559 1.10%
1970 Q2 99.82 20.71 102 4,013,000 5,758 0.93%
1970 Q3 99.64 20.90 104 4,040,000 5,956 1.00%
1970 Q4 99.47 21.09 106 4,067,000 6,155 1.13%
1971 Q1 99.29 21.28 107 4,094,000 6,353 1.13%
1971 Q2 99.11 21.90 107 4,123,250 6,523 1.17%
1971 Q3 98.93 22.51 109 4,152,500 6,694 1.37%
1971 Q4 98.76 23.13 110 4,181,750 6,864 1.83%
1972 Q1 98.58 23.74 111 4,211,000 7,034 2.27%
1972 Q2 100.03 -18 24.14 112 4,242,500 7,261 2.43%
1972 Q3 101.48 -13.5 24.53 115 4,274,000 7,488 2.50%
1972 Q4 102.93 -9 24.93 116 4,305,500 7,714 2.50%
1973 Q1 104.38 -6 25.32 118 4,337,000 7,941 2.43%
1973 Q2 106.34 -3 25.94 119 4,366,250 8,168 2.50%
1973 Q3 109.63 1 26.55 123 4,395,500 8,395 2.43%
1973 Q4 106.53 5 27.16 125 4,424,750 8,622 2.43%
1974 Q1 108.70 -28 27.77 126 4,454,000 8,849 2.73%
1974 Q2 107.64 -6 28.39 125 4,480,750 9,246 2.87%
1974 Q3 106.59 -8 29.00 125 4,507,500 9,643 3.07%
1974 Q4 105.53 -10 29.61 124 4,534,250 10,040 3.43%
1975 Q1 106.61 -22 30.22 123 4,561,000 10,437 5.53%
1975 Q2 108.79 -14 30.62 124 4,585,750 10,749 5.77%
1975 Q3 109.86 -17.5 31.02 126 4,610,500 11,061 5.73%
1975 Q4 113.16 -21 31.42 127 4,635,250 11,373 6.07%
1976 Q1 123.66 -11 31.82 129 4,660,000 11,685 6.33%
1976 Q2 126.97 -9 33.14 127 4,683,000 11,940 6.20%
1976 Q3 133.77 -9.5 34.47 129 4,706,000 12,196 6.10%
1976 Q4 140.58 -10 35.79 128 4,729,000 12,451 6.00%
1977 Q1 149.79 -3 37.12 130 4,752,000 12,706 6.00%
1977 Q2 164.06 -1 37.74 129 4,773,750 12,933 6.00%
1977 Q3 173.30 -7 38.35 131 4,795,500 13,160 6.00%
1977 Q4 177.80 -13 38.97 132 4,817,250 13,386 6.00%
1978 Q1 182.31 5 39.59 134 4,839,000 13,613 5.70%
1978 Q2 189.14 -4 40.21 134 4,857,000 13,783 5.63%
1978 Q3 186.97 -8.5 40.83 135 4,875,000 13,954 5.77%
1978 Q4 184.79 -13 41.45 136 4,893,000 14,124 5.80%
1979 Q1 181.55 -10 42.07 137 4,911,000 14,294 5.80%
1979 Q2 178.31 -12 42.91 138 4,934,750 14,521 5.80%
1979 Q3 176.14 -15 43.75 139 4,958,500 14,748 5.80%
1979 Q4 172.89 -18 44.59 140 4,982,250 14,975 5.77%
1980 Q1 165.51 -28 45.43 140 5,006,000 15,202 3.90%
1980 Q2 158.13 -35 46.27 139 5,030,250 15,372 4.10%
1980 Q3 152.79 -38.5 47.11 138 5,054,500 15,542 4.33%
1980 Q4 150.61 -42 47.96 139 5,078,750 15,712 4.73%
1981 Q1 142.24 -41 48.80 138 5,103,000 15,882 5.20%
1981 Q2 135.87 -43 49.87 137 5,137,000 15,996 5.60%
1981 Q3 126.54 -42 50.94 136 5,171,000 16,109 6.00%
1981 Q4 117.20 -41 52.01 134 5,205,000 16,223 6.47%
1982 Q1 110.81 -43 53.08 134 5,239,000 16,336 6.93%
1982 Q2 108.59 -38 54.38 133 5,271,000 16,563 7.43%
1982 Q3 107.47 -43 55.69 133 5,303,000 16,790 7.93%
1982 Q4 105.26 -48 56.99 133 5,335,000 17,017 8.43%
1983 Q1 104.14 -46 58.30 134 5,367,000 17,244 8.90%
1983 Q2 105.28 -38 59.60 135 5,398,750 17,357 9.17%
1983 Q3 105.28 -37 60.91 135 5,430,500 17,471 9.40%
1983 Q4 104.16 -36 62.21 136 5,462,250 17,584 9.40%
1984 Q1 104.16 -27 63.52 136 5,494,000 17,697 9.33%
1984 Q2 103.04 -22 64.37 136 5,523,750 17,811 9.10%
1984 Q3 100.83 -19 65.21 137 5,553,500 17,924 8.73%
1984 Q4 98.61 -20 66.06 137 5,583,250 18,038 8.37%
1985 Q1 98.61 -8 66.91 138 5,613,000 18,151 8.03%
1985 Q2 93.50 -9 67.53 139 5,637,500 18,265 7.97%
1985 Q3 94.20 -1 68.16 140 5,662,000 18,378 7.77%
1985 Q4 93.13 3 68.79 141 5,686,500 18,492 7.77%
1986 Q1 93.01 12 69.42 141 5,711,000 18,605 7.80%
1986 Q2 96.00 11 70.04 141 5,736,750 18,605 7.80%
1986 Q3 98.26 7 70.67 141 5,762,500 18,605 7.87%
1986 Q4 97.80 4 71.30 142 5,788,250 18,605 7.90%
1987 Q1 97.09 8 71.92 142 5,814,000 18,605 7.83%
1987 Q2 100.11 -1 72.34 142 5,819,750 18,605 7.73%
1987 Q3 101.62 -3 72.75 142 5,825,500 18,605 7.67%
1987 Q4 100.51 -7 73.17 142 5,831,250 18,605 7.40%
1988 Q1 99.65 -2 73.58 143 5,837,000 18,605 7.27%
1988 Q2 102.99 0 74.21 144 5,862,250 18,605 7.23%
1988 Q3 106.64 4 74.83 146 5,887,500 18,605 7.17%
1988 Q4 106.02 6 75.46 147 5,912,750 18,605 7.00%
1989 Q1 105.66 14 76.09 149 5,938,000 18,605 6.73%
1989 Q2 108.92 12 76.71 151 5,968,750 18,719 6.67%
1989 Q3 111.61 15 77.34 152 5,999,500 18,832 6.60%
1989 Q4 111.22 13 77.97 153 6,030,250 18,946 6.30%
a www.nvm.nl
c www.cbs.nl
d www.cbs.nl
e www.oecd.org
h www.cbs.nl
i www.cbs.nl
j www.oecd.org
170
current prices
1970 = 100 1970=100 current prices
Consumer Real Rent Number of Nominal Median Income Percentage

Year Quarter Real Houseprice Index ͣ Confidence ͨ Index ͩ Real GDP Index ͤ Householdsʰ Households ͥ Unemployment ʲ
1990 Q1 110.19 14 78.60 155 6,061,000 19,059 6.03%
1990 Q2 111.84 9 79.22 156 6,086,750 19,286 5.87%
1990 Q3 111.48 5 79.85 157 6,112,500 19,513 5.83%
1990 Q4 107.99 -10 80.48 158 6,138,250 19,739 5.70%
1991 Q1 106.57 -10 81.10 160 6,164,000 19,966 5.63%
1991 Q2 108.66 -10 81.95 161 6,189,500 20,193 5.60%
1991 Q3 109.80 -14 82.79 160 6,215,000 20,420 5.47%
1991 Q4 109.47 -20 83.64 161 6,240,500 20,647 5.20%
1992 Q1 110.11 -15 84.48 162 6,266,000 20,874 5.20%
1992 Q2 113.40 -13 85.78 162 6,291,500 21,101 5.37%
1992 Q3 116.35 -7 87.07 163 6,317,000 21,328 5.27%
1992 Q4 116.74 -19 88.36 164 6,342,500 21,554 5.47%
1993 Q1 117.72 -22 89.66 164 6,368,000 21,781 5.87%
1993 Q2 121.70 -25 90.95 164 6,387,250 21,781 6.17%
1993 Q3 124.84 -19 92.24 164 6,406,500 21,781 6.40%
1993 Q4 126.50 -23 93.53 164 6,425,750 21,781 6.50%
1994 Q1 128.89 -16 94.83 165 6,445,000 21,781 6.83%
1994 Q2 131.68 -9 96.12 166 6,451,000 21,895 6.63%
1994 Q3 132.65 1 97.41 167 6,457,000 22,008 6.73%
1994 Q4 131.09 -4 98.71 168 6,463,000 22,122 6.90%
1995 Q1 129.88 3 100.00 169 6,469,000 22,235 6.83%
1995 Q2 131.63 3 101.17 171 6,481,250 22,349 6.63%
1995 Q3 134.52 8 102.34 173 6,493,500 22,462 6.40%
1995 Q4 136.46 3 103.52 174 6,505,750 22,576 6.40%
1996 Q1 138.30 -2 104.69 175 6,518,000 22,689 6.17%
1996 Q2 142.17 -4 105.44 176 6,533,750 22,803 5.90%
1996 Q3 145.39 5 106.19 177 6,549,500 22,916 6.00%
1996 Q4 147.35 4 106.94 178 6,565,250 23,030 5.77%
1997 Q1 148.73 12 107.70 181 6,581,000 23,143 5.27%
1997 Q2 152.77 15 109.33 183 6,599,750 23,257 5.10%
1997 Q3 156.49 19 110.97 185 6,618,500 23,370 4.93%
1997 Q4 155.31 14 112.61 187 6,637,250 23,484 4.43%
1998 Q1 155.69 20 114.25 189 6,656,000 23,597 4.27%
1998 Q2 159.90 23 114.53 190 6,678,250 23,710 3.80%
1998 Q3 164.63 22 114.81 192 6,700,500 23,824 3.67%
1998 Q4 168.09 4 115.09 194 6,722,750 23,937 3.57%
1999 Q1 172.85 7 115.37 196 6,745,000 24,050 3.50%
1999 Q2 180.95 10 115.91 198 6,759,000 24,277 3.27%
1999 Q3 191.18 18 116.45 200 6,773,000 24,504 3.33%
1999 Q4 198.42 21 116.99 203 6,787,000 24,731 2.83%
2000 Q1 201.86 26 117.53 206 6,801,000 24,958 2.90%
2000 Q2 207.65 26 115.59 208 6,817,500 25,469 2.83%
2000 Q3 214.53 25 113.64 211 6,834,000 25,979 2.83%
2000 Q4 216.89 20 111.70 213 6,850,500 26,490 2.77%
2001 Q1 215.48 10 109.76 214 6,867,000 27,000 2.23%
2001 Q2 216.91 -1 113.25 215 6,883,750 27,250 2.20%
2001 Q3 220.97 -4 116.74 217 6,900,500 27,500 2.27%
2001 Q4 220.88 -9 120.23 219 6,917,250 27,750 2.30%
2002 Q1 219.94 -5 123.72 219 6,934,000 28,000 2.53%
2002 Q2 222.73 -17 124.45 219 6,949,500 28,125 2.60%
2002 Q3 225.88 -27 125.18 221 6,965,000 28,250 2.87%
2002 Q4 223.86 -32 125.90 222 6,980,500 28,375 3.03%
2003 Q1 220.12 -36 126.63 221 6,996,000 28,500 3.33%
2003 Q2 219.91 -36 127.43 222 7,009,250 28,625 3.63%
2003 Q3 223.57 -35 128.22 222 7,022,500 28,750 3.83%
2003 Q4 225.79 -33 129.02 223 7,035,750 28,875 4.00%
2004 Q1 226.08 -26 129.81 224 7,049,000 29,000 4.40%
2004 Q2 227.65 -26 130.92 225 7,059,500 29,000 4.67%
2004 Q3 228.33 -20 132.02 226 7,070,000 29,000 4.50%
2004 Q4 228.22 -29 133.13 227 7,080,500 29,000 4.67%
2005 Q1 227.54 -22 134.23 228 7,091,000 29,000 4.87%
2005 Q2 230.83 -21 135.68 229 7,104,750 29,125 4.80%
2005 Q3 235.41 -25 137.12 231 7,118,500 29,250 4.63%
2005 Q4 236.92 -21 138.57 234 7,132,250 29,375 4.50%
2006 Q1 236.44 -11 140.01 235 7,146,000 29,500 4.23%
2006 Q2 239.80 -1 238 7,157,250 29,625 3.93%
2006 Q3 244.14 5 240 7,168,500 29,750 3.83%
2006 Q4 245.51 5 243 7,179,750 29,875 3.67%
2007 Q1 243.85 13 245 7,191,000 30,000 3.50%
2007 Q2 245.81 14 246 7,203,750 30,244 3.23%
2007 Q3 249.19 10 248 7,216,500 30,488 3.10%
2007 Q4 248.57 -5 251 7,229,250 30,731 2.90%
2008 Q1 244.57 -7 252 7,242,000 30,975 2.80%
2008 Q2 243.93 -16 252 7,259,750 30,983 2.83%
2008 Q3 244.99 -26 254 7,277,500 30,992 2.70%
2008 Q4 236.89 -31 257 7,295,250 31,000 2.73%
2009 Q1 228.97 -30 254 7,313,000 31,375 2.93%
2009 Q2 229.66 -24 248 31,750 3.30%
2009 Q3 232.13 -18 248 32,125 3.63%
2009 Q4 232.25 -18 245 32,500 3.93%
171
1970 = 100 current prices
Nominal Building Nominal Median Sales Price total residential mortgage debt Short Term Long Term
Year Quarter Costs Index ͫ Exisiting Homes ͦ Housing Stockʳ outstanding ͧ Interest Rateˢ Interest Rate ͭ Change in CPI ͮ
1970 Q1 100.00 24,522 3,787,000.00 8,282,479,549 7.99% 100
1970 Q2 103.16 24,817 3,816,750.00 8,513,383,123 8.13% 72.38
1970 Q3 106.31 25,080 3,846,500.00 8,760,102,010 8.02% 88.63
1970 Q4 109.47 25,373 3,876,250.00 9,073,245,212 7.91% 107.47
1971 Q1 112.62 25,940 3,906,000.00 9,380,062,289 7.56% 142.03
1971 Q2 115.78 26,535 3,940,000.00 9,707,439,273 7.50% 167.03
1971 Q3 118.93 26,793 3,974,000.00 10,041,142,383 7.68% 164.99
1971 Q4 122.09 27,232 4,008,000.00 10,414,383,776 7.76% 175.92
1972 Q1 125.25 28,220 4,042,000.00 10,724,363,915 7.37% 169.20
1972 Q2 128.40 29,351 4,077,250.00 11,168,774,218 7.48% 170.11
1972 Q3 131.56 29,993 4,112,500.00 11,477,172,826 7.25% 160.75
1972 Q4 134.71 31,158 4,147,750.00 12,241,052,456 7.32% 174.88
1973 Q1 137.87 32,300 4,183,000.00 12,587,407,816 7.38% 166.48
1973 Q2 141.02 34,316 4,215,500.00 13,020,747,399 7.55% 178.63
1973 Q3 144.18 33,608 4,248,000.00 13,330,727,539 8.29% 179.61
1973 Q4 147.34 35,066 4,280,500.00 13,936,454,037 8.45% 175.33
1974 Q1 150.49 35,557 4,313,000.00 14,170,520,673 9.32% 189.97
1974 Q2 153.65 36,296 4,331,750.00 14,771,502,576 10.05% 190.78
1974 Q3 156.80 36,556 4,350,500.00 15,111,531,811 10.44% 212.68
1974 Q4 159.96 38,115 4,369,250.00 16,458,996,500 9.49% 235.03
1975 Q1 163.11 39,733 4,388,000.00 17,075,793,717 8.86% 229.53
1975 Q2 167.27 41,247 4,411,000.00 17,923,494,507 8.59% 222.66
1975 Q3 171.43 43,358 4,434,000.00 18,369,486,341 8.89% 230.51
1975 Q4 175.59 48,413 4,457,000.00 19,539,819,521 8.82% 206.45
1976 Q1 179.75 50,651 4,480,000.00 20,477,667,597 8.35% 200.24
1976 Q2 183.91 55,018 4,504,500.00 20,963,197,714 8.81% 207.31
1976 Q3 188.07 58,293 4,529,000.00 21,505,662,959 9.82% 178.62
1976 Q4 192.23 63,551 4,553,500.00 22,255,308,807 8.83% 181.67
1977 Q1 196.39 70,212 4,578,000.00 23,147,292,474 8.36% 158.11
1977 Q2 200.55 76,041 4,601,500.00 23,411,408,205 8.13% 145.20
1977 Q3 204.71 78,511 4,625,000.00 23,993,411,733 7.82% 140.77
1977 Q4 208.87 81,400 4,648,500.00 24,856,927,836 8.09% 113.87
1978 Q1 213.03 84,628 4,672,000.00 25,388,322,362 7.58% 98.77
1978 Q2 217.19 84,926 4,690,750.00 26,073,125,425 7.34% 76.46
1978 Q3 221.35 85,081 4,709,500.00 26,756,346,958 7.75% 92.69
1978 Q4 225.51 84,317 4,728,250.00 28,298,340,000 8.27% 87.16
1979 Q1 229.67 83,197 4,747,000.00 28,644,695,360 8.39% 92.98
1979 Q2 233.83 83,434 4,772,750.00 29,329,498,424 8.79% 93.06
1979 Q3 237.99 82,647 4,798,500.00 29,903,594,295 8.83% 83.07
1979 Q4 242.15 80,398 4,824,250.00 31,445,587,337 9.10% 99.69
1980 Q1 246.31 78,035 4,850,000.00 32,465,675,041 10.41% 125.11
1980 Q2 246.05 77,004 4,876,750.00 33,987,108,176 10.18% 138.81
1980 Q3 245.78 77,114 4,903,500.00 34,940,771,565 9.86% 154.40
1980 Q4 245.51 73,709 4,930,250.00 36,909,778,065 10.38% 145.04
1981 Q1 245.25 71,584 4,957,000.00 37,543,972,126 10.92% 146.85
1981 Q2 244.98 67,839 4,985,750.00 38,641,554,866 11.54% 138.46
1981 Q3 244.71 63,921 5,014,500.00 40,080,748,372 12.00% 141.53
1981 Q4 244.45 61,598 5,043,250.00 41,564,224,755 11.75% 157.97
1982 Q1 244.18 61,205 5,072,000.00 42,608,035,429 10.86% 151.55
1982 Q2 243.91 61,338 5,098,500.00 43,697,710,512 10.28% 140.17
1982 Q3 243.65 60,724 5,125,000.00 44,955,027,916 10.24% 125.49
1982 Q4 243.38 60,496 5,151,500.00 47,811,273,489 9.01% 97.77
1983 Q1 243.11 61,194 5,178,000.00 49,079,661,611 8.07% 67.86
1983 Q2 242.85 61,616 5,205,750.00 50,529,925,837 8.84% 55.26
1983 Q3 242.58 61,540 5,233,500.00 51,391,860,409 8.97% 52.34
1983 Q4 242.32 62,216 5,261,250.00 50,499,876,741 8.56% 61.22
1984 Q1 242.05 62,088 5,289,000.00 51,796,732,428 8.51% 79.65
1984 Q2 241.78 61,221 5,312,750.00 52,190,533,728 8.55% 81.40
1984 Q3 241.52 59,997 5,336,500.00 53,526,927,698 8.48% 64.73
1984 Q4 241.25 60,606 5,360,250.00 54,577,064,497 7.77% 62.91
1985 Q1 240.98 57,494 5,384,000.00 55,059,431,552 7.76% 44.54
1985 Q2 242.73 58,012 5,408,750.00 56,009,931,878 7.53% 30.94
1985 Q3 244.47 57,498 5,433,500.00 56,419,548,491 7.02% 31.98
1985 Q4 246.21 57,421 5,458,250.00 60,749,781,259 7.00% 9.83
1986 Q1 247.95 59,444 5,483,000.00 61,784,102,746 5.74% 6.70% 15.28
1986 Q2 249.69 60,967 5,509,500.00 62,222,186,923 5.76% 6.26% 16.34
1986 Q3 251.43 60,743 5,536,000.00 63,666,125,023 5.50% 6.09% 13.04
1986 Q4 253.18 60,304 5,562,500.00 63,783,158,341 5.73% 6.22% 13.04
1987 Q1 254.92 62,240 5,589,000.00 64,229,150,174 5.54% 6.18% 8.67
1987 Q2 256.66 63,271 5,616,500.00 65,140,112,218 5.31% 6.15% 7.57
1987 Q3 258.40 62,610 5,644,000.00 65,834,404,469 5.37% 6.64% 6.48
1987 Q4 260.14 62,104 5,671,500.00 66,770,671,014 5.22% 6.64% 7.56
1988 Q1 261.89 64,160 5,699,000.00 67,920,444,287 4.18% 6.23% 4.32
1988 Q2 263.63 66,628 5,724,750.00 69,100,266,656 4.15% 6.39% 7.54
1988 Q3 265.37 66,240 5,750,500.00 70,765,619,141 5.41% 6.66% 6.46
1988 Q4 267.11 66,213 5,776,250.00 71,958,093,760 5.52% 6.38% 11.84
1989 Q1 268.85 68,286 5,802,000.00 72,223,791,023 6.65% 6.91% 14.00
1989 Q2 270.59 70,115 5,824,500.00 73,759,457,939 7.15% 7.22% 11.81
1989 Q3 272.34 70,247 5,847,000.00 74,256,058,775 7.36% 7.11% 23.63
1989 Q4 274.08 69,936 5,869,500.00 75,575,055,901 8.40% 7.63% 27.84
m www.cbs.nl
o www.nvm.nl
r www.cbs.nl
s www.oecd.org
t www.oecd.org
u www.dnb.nl & www.imf.org
172
1970 = 100 current prices
Nominal Building Nominal Median Sales Price total residential mortgage debt Short Term Long Term
Year Quarter Costs Index ͫ Exisiting Homes ͦ Housing Stockʳ outstanding ͧ Interest Rateˢ Interest Rate ͭ Change in CPI ͮ
1990 Q1 275.82 71,259 5,892,000.00 76,648,565,217 8.91% 8.66% 35.32
1990 Q2 278.42 71,544 5,910,500.00 77,722,074,534 8.47% 8.93% 47.00
1990 Q3 281.02 69,909 5,929,000.00 78,795,583,851 8.44% 8.96% 54.18
1990 Q4 283.63 69,547 5,947,500.00 79,869,093,168 8.91% 9.13% 61.32
1991 Q1 286.23 71,181 5,966,000.00 81,372,006,211 9.22% 8.82% 61.08
1991 Q2 288.83 72,438 5,985,250.00 82,874,919,255 9.16% 8.60% 60.64
1991 Q3 291.43 73,336 6,004,500.00 84,377,832,298 9.27% 8.81% 75.66
1991 Q4 294.04 74,378 6,023,750.00 85,880,745,342 9.48% 8.73% 76.08
1992 Q1 296.64 77,051 6,043,000.00 87,168,956,522 9.59% 8.33% 80.92
1992 Q2 299.24 79,740 6,061,250.00 88,457,167,702 9.51% 8.31% 84.42
1992 Q3 301.84 80,373 6,079,500.00 89,745,378,882 9.58% 8.25% 60.09
1992 Q4 304.45 81,552 6,097,750.00 91,033,590,062 8.73% 7.52% 55.63
1993 Q1 307.05 84,728 6,116,000.00 94,039,416,149 7.93% 6.85% 53.32
1993 Q2 309.65 87,568 6,135,000.00 97,045,242,236 7.11% 6.62% 50.91
1993 Q3 312.25 89,435 6,154,000.00 100,051,068,323 6.42% 6.20% 58.48
1993 Q4 314.86 91,839 6,173,000.00 103,056,894,410 5.95% 5.77% 61.99
1994 Q1 317.46 94,315 6,192,000.00 103,915,701,863 5.28% 5.92% 62.65
1994 Q2 320.06 95,708 6,213,000.00 107,350,931,677 5.16% 6.80% 62.18
1994 Q3 322.66 95,152 6,234,000.00 110,786,161,491 4.99% 7.17% 57.89
1994 Q4 325.27 94,917 6,255,000.00 113,362,583,851 5.28% 7.56% 55.56
1995 Q1 327.87 96,599 6,276,000.00 115,939,006,211 5.13% 7.56% 53.40
1995 Q2 331.97 99,096 6,296,500.00 118,515,428,571 4.49% 6.97% 45.57
1995 Q3 336.07 100,818 6,317,000.00 121,091,850,932 4.07% 6.72% 38.83
1995 Q4 340.16 102,695 6,337,500.00 125,385,888,199 3.81% 6.34% 34.89
1996 Q1 344.26 106,046 6,358,000.00 128,821,118,012 3.18% 6.18% 35.66
1996 Q2 348.36 109,168 6,378,750.00 133,973,962,733 2.85% 6.39% 41.90
1996 Q3 352.46 111,234 6,399,500.00 138,268,000,000 2.97% 6.25% 47.22
1996 Q4 356.56 112,733 6,420,250.00 144,265,000,000 2.99% 5.79% 45.18
1997 Q1 360.66 116,311 6,441,000.00 149,533,000,000 3.08% 5.59% 44.98
1997 Q2 364.75 119,972 6,461,250.00 157,093,000,000 3.22% 5.70% 45.57
1997 Q3 368.85 119,592 6,481,500.00 163,866,000,000 3.37% 5.55% 43.55
1997 Q4 372.95 120,797 6,501,750.00 171,391,000,000 3.67% 5.47% 51.34
1998 Q1 377.05 124,462 6,522,000.00 176,485,000,000 3.46% 5.01% 48.47
1998 Q2 381.15 128,856 6,539,000.00 182,742,000,000 3.58% 4.93% 45.51
1998 Q3 385.25 132,138 6,556,000.00 189,581,000,000 3.43% 4.49% 45.31
1998 Q4 389.34 136,461 6,573,000.00 197,702,000,000 3.36% 4.09% 38.05
1999 Q1 393.44 143,700 6,590,000.00 205,724,000,000 3.09% 3.96% 43.96
1999 Q2 397.54 153,004 6,605,250.00 217,189,000,000 2.63% 4.23% 48.86
1999 Q3 401.64 159,352 6,620,500.00 226,067,000,000 2.70% 5.02% 46.95
1999 Q4 405.74 162,800 6,635,750.00 234,385,000,000 3.43% 5.30% 46.74
2000 Q1 409.84 168,302 6,651,000.00 241,209,000,000 3.54% 5.60% 44.78
2000 Q2 414.24 175,336 6,665,750.00 249,879,000,000 4.26% 5.40% 46.11
2000 Q3 418.65 178,336 6,680,500.00 253,249,000,000 4.74% 5.39% 51.80
2000 Q4 423.05 178,910 6,695,250.00 285,252,000,000 5.02% 5.23% 64.06
2001 Q1 427.46 182,442 6,710,000.00 297,228,000,000 4.75% 4.89% 81.96
2001 Q2 431.86 188,382 6,723,500.00 302,639,000,000 4.59% 5.14% 93.59
2001 Q3 436.27 189,397 6,737,000.00 312,172,000,000 4.27% 5.04% 93.03
2001 Q4 440.68 190,022 6,750,500.00 320,224,000,000 3.44% 4.76% 88.09
2002 Q1 445.08 194,425 6,764,000.00 338,893,000,000 3.36% 5.09% 82.17
2002 Q2 449.49 199,130 6,775,500.00 350,391,000,000 3.45% 5.24% 73.98
2002 Q3 453.89 197,764 6,787,000.00 359,145,000,000 3.36% 4.73% 65.73
2002 Q4 458.30 195,544 6,798,500.00 367,897,000,000 3.11% 4.50% 61.35
2003 Q1 462.70 196,650 6,810,000.00 377,038,000,000 2.68% 4.06% 53.04
2003 Q2 467.11 201,099 6,822,250.00 388,339,000,000 2.36% 3.95% 44.14
2003 Q3 471.52 203,586 6,834,500.00 396,097,000,000 2.14% 4.15% 44.81
2003 Q4 475.92 204,270 6,846,750.00 400,153,000,000 2.15% 4.34% 37.01
2004 Q1 480.33 206,876 6,859,000.00 407,414,000,000 2.06% 4.08% 35.27
2004 Q2 484.73 207,922 6,872,250.00 417,779,000,000 2.08% 4.31% 26.85
2004 Q3 489.14 208,460 6,885,500.00 426,982,000,000 2.12% 4.18% 28.28
2004 Q4 493.55 208,612 6,898,750.00 433,383,000,000 2.16% 3.81% 31.93
2005 Q1 497.95 212,550 6,912,000.00 439,501,000,000 2.14% 3.60% 28.79
2005 Q2 499.39 217,929 6,925,750.00 452,502,000,000 2.12% 3.30% 36.10
2005 Q3 500.82 219,839 6,939,500.00 463,246,000,000 2.13% 3.22% 34.53
2005 Q4 502.25 219,835 6,953,250.00 480,191,000,000 2.34% 3.37% 30.74
2006 Q1 503.69 224,290 6,967,000.00 482,444,000,000 2.61% 3.49% 34.25
2006 Q2 505.12 228,802 6,982,500.00 493,989,000,000 2.89% 3.95% 26.82
2006 Q3 506.56 230,769 6,998,000.00 497,017,000,000 3.22% 3.89% 28.20
2006 Q4 507.99 229,664 7,013,500.00 510,156,000,000 3.59% 3.79% 28.14
2007 Q1 509.43 232,501 7,029,000.00 524,974,000,000 3.82% 4.03% 24.39
2007 Q2 515.57 237,546 7,048,500.00 528,035,000,000 4.06% 4.37% 37.23
2007 Q3 526.23 237,795 7,068,000.00 541,093,000,000 4.50% 4.43% 38.55
2007 Q4 540.16 234,275 7,087,500.00 551,873,000,000 4.72% 4.31% 37.05
2008 Q1 552.05 235,539 7,092,375.00 559,914,000,000 4.48% 4.05% 45.40
2008 Q2 550.00 239,821 7,097,250.00 565,794,000,000 4.86% 4.43% 58.42
2008 Q3 552.05 232,484 7,102,125.00 570,983,000,000 4.98% 4.48% 56.11
2008 Q4 562.70 224,711 7,107,000.00 588,188,000,000 4.21% 3.95% 53.24
2009 Q1 555.74 225,947 7,124,071.50 590,485,000,000 2.01% 3.74% 41.00
2009 Q2 552.46 230,896 7,141,143.00 607,277,000,000 1.31% 3.86% 34.96
2009 Q3 550.82 229,000 7,158,214.50 609,559,000,000 0.87% 3.65% 10.26
2009 Q4 534.43 7,175,286.00 619,992,000,000 0.72% 3.50% 15.73
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An Investigation Into The Housing Market

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An Investigation Into The Housing Market

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a fundamental economic inquiry

Maurits van der Vegt

TVE Studio 2010

An investigation into the housing market

A fundamental economic inquiry

Student: M. van der Vegt

Part I: Exploring the Theoretic World

Chapter One: A Rollercoaster of Economic Theory 11

Part II: The case studies

Chapter Five: Introducing the American and Dutch Cases 72

Conclusion: Where Are The Regulators? 152

Figure 31 – American Housing Boom of 1983 to 1989 121

“25-standard deviation events, several days in a row”

Asset Prices and Stabilizing Economic and Monetary Policies

Exploring the Theoretic World

Chapter One: A rollercoaster of Economic Theory

1.1 A history of macroeconomic theory 16

Keynes and Orthodox Keynesianism

useless as the effects by higher government expenditures would be anticipated on by economic

New Classicists & the Real Business Cycle

deviations, as the system is considered to be self-stabilizing. But as the empirical evidence is so

New Keynesians & the “New Neoclassical Synthesis”

differences of inflationary expectations between different groups of people (inflationary expectations

1.2 Assumptions from macro-economic theory within this paper

2) The structure of the housing market:

3) The price determination process:

Chapter Two: Theorizing The Housing Market

2.1 The Housing Market: How to look at it?

From a macro perspective

The determinants of the housing market

2.2 Housing market from a theoretical perspective

Asset pricing models and the housing market

1) Present Value model

2) Rent model (rent gap theory)

3) Supply & Demand model

4) Land based model

5) Q-theory / Portfolio Theory

6) Efficient Market Theory Based pricing models

Housing market models

1. Housing Market Efficiency

2. Imperfect markets: information asymmetries

3. Imperfect markets: imperfect competition

4. Local network perspective 159

1) The (in)efficiency of the housing market

2) The structure of the housing market (frictions and rigidities)

3) The price determination process

Chapter 3: What about bubbles?

3.1 Bubbles in economic theory

Credit & Asset cycles

New Economy bubbles

Bubbles in imperfect markets

Bubbles and behavioural economics

3.2 Housing Market Bubbles

Rational Housing Bubbles

Behavioural ‘Minsky’ Housing Bubbles

Credit & Asset cycles in the housing market

Behavioural dominated Bubbles

3.3 Bubbles here, bubbles there, bubbles everywhere?

Chapter Four: A Framework for Analyzing the Housing Market

4.1 The boom bust cycle and how to identify a bubble

4.2 Long term trends and fundamentals

4.3 In-depth analysis of the booms, busts and flat periods

4.3 Summarizing the analysis