I have mentioned before that narratives of the housing bubble tend to presume a schizophrenic model of rational expectations. Home buyers were bidding prices up because of irrational exuberance and also because various public subsidies and programs lower the price of homeownership. In the case of the former, these buyers were paying for homes with little regard for intrinsic value or relative cash flows, or they were buying them with exaggerated expectations of those cash flows. In the case of the latter, buyers were paying more for homes because the present value of far future imputed rental income and capital gains were being precisely increased by tax deductions and interest rate subsidies.
There is a related schizophrenia in the way home demand has been described during the period. Mortgage brokers were aggressive because they were being paid from the high fees and high interest rate income generated by subprime borrowers. The private securitization business is usually described as an engorgement of the shadow banking sector on these fees. On the other hand, home buyers were attracted to the market because government support of the GSEs lowered mortgage rates and the Fed (supposedly) was pushing rates down by goosing the money supply.
Now, again, I suppose it is possible for both of these effects to be in play. Rates could be low at the same time that mortgage brokers are aggressively trolling for fee income, and both of these factors could lead to more demand for homes. But, demand elasticity is sort of doing the tango here. With regard to basic rates, demand is elastic, so that lower rates lead to more buying. But, when it comes to the privately securitized mortgages, demand has to be inelastic or else there would be strong headwinds against those brokers expanding the market.
In a way, I acknowledge that both of these things were happening in the two Americas. Lower conventional rates did cause home prices in most of the country to rise moderately - maybe about 20% from trough to peak as real interest rates declined. In the Closed Access cities, demand for home buying was less elastic because lack of access had been holding lower priced homes down. There had been no regulatory or market barriers keeping families from spending 40% or 50% of their incomes on rent, but there had been barriers to spending 40% or 50% of their incomes on mortgage payments. As those barriers were removed, pent up demand for home ownership was released.
This led to prices rising in the Closed Access cities in a systematic way. It led to a burst of tactical selling from existing Closed Access home owners and a surge of out-migration as those families moved on with their capital gains in hand.
There are ways that segments of the market reacted differently, and those different reactions are sometimes related to changes in the marketplace for mortgages. What I find frustrating about the conventional credit supply explanations for the "bubble" is that these subtleties are rarely addressed. There is a market called "America", where non-conventional mortgages, housing starts, debt levels, and prices were all rising at the same time while conventional interest rates were low. And, as that story gets told, demand elasticity moves to and fro as needed, usually with little apparent notice. In that story, households with a lack of self control are blamed, oddly, for a surge in transactions that may represent the single most back-weighted arrangement of cash flows a household could engage in. In that story, we have to pretend that $2 trillion in mortgage debt was pushed through these securitization fee machines to those households who lacked self-control and then disappeared - somehow not showing up at all in the balance sheets of households with below average incomes.