from Barron's -
OCTOBER 25, 1999
House Prices Have Soared, But You Wouldn't
Know It From the CPI
By Gene Epstein
Over the past 12 months, the cost of buying the average home
has jumped by 10%, with half of the rise accounted for by the
increase in the purchase price and the other half by the climb in
the mortgage interest rate.
But you wouldn't know it from the official measure of the
nation's cost of living, the consumer price index. As the CPI
would have it, the tab for homeownership is up over the same
period by only 2.5%.
While the consumer price index has often been criticized for
overstating the true rate of inflation, this seems to be a glaring
case of just the opposite. But before we cry foul, we should first
look at how the Bureau of Labor Statistics treats homeownership
costs in the CPI. For it turns out that there are no good solutions
to this metaphysical problem, only workable strategies. And the
one the BLS has devised is probably better than most, even if it
has its comical side.
Up until 1983, the consumer price index actually did track what
most of us would normally associate with home ownership costs:
house prices, mortgage interest rates, insurance, taxes,
maintenance and repair. But then, virtually all of this was
scrapped for something dubbed "owner's equivalent rent." The
OER, which today accounts for nearly 20% of the total CPI, is
supposed to reflect what homeowners would pay if they were
renting their homes to themselves.
In other words, it turns us into a nation of tenants, both the
approximately 32% of households that actually are tenants and
the 68% that own their own homes. (Rents make up 7% of the
CPI and rose 2.9% over the past 12 months.)
Now, of course, when you get right down to it, the OER is all
about the fool's game of tracking phantom rents. Estimating
what a homeowner would pay himself if he were his own tenant
makes no more sense than figuring what a tenant would pay to
own the home he rents. And on top of that, the game involves
charting how these bogus prices change over time.
So the keepers of the CPI are forced to prowl the
neighborhoods, in the occasionally fruitless search for homes
that are being rented. And assuming they find one, they key the
local OER off the rent that is being charged.
As a Bureau of Labor Statistics economist, Patrick Jackman,
explains: "In the owner-dominated areas you don't have many
rental units. And sometimes you find only one unit that is
supposed to represent the entire set of owners in a given area.
So you often have to expand the neighborhood in order to find
rental units that are supposed to represent those owner
dwellings." In other words, you might end up marking Scarsdale
to rented homes in Yonkers.
But despite its obvious flaws, owner's equivalent rent beats the
alternative route of following house values and mortgage rates.
To begin with, in any given year the change in those prices
directly affects only a small minority, since only about 6% of
households generally buy a new or existing home. Moreover,
most of this 6% already own a home that they're selling, usually
because they're moving to another region or "trading up." So
their real cost consists of the spread between the price of the
asset they're giving up and the one they're acquiring.
Investment Gain
And finally, the vast majority of homeowners are neither buying
nor selling, but simply staying put. So the better than 5% rise in
the median house price over the past 12 months is mainly good
news for them, quite similar to a 5% appreciation in the value of
their stocks and bonds.
All of which gets back to the basic reason the Bureau of Labor
Statistics created the concept of owner's equivalent rent. As
Jackman puts it, the whole point is to "get rid of the investment
component of owning a home" and to try to track "what it would
cost to consume the services of a home." Theoretically, at least,
that's what renters do.
But still, given
the abstract
nature of the
OER, it's
always
refreshing to
know what's
been
happening in
the concrete
world of real
transactions.
The two charts
compare the
OER with the
monthly
mortgage cost
on the
median-priced home over the recent period and over the long
term. As noted, over the past 12 months, the principal and
interest payment is up about 10%, while the OER has risen by
just 2.5%.
But since 1983, the OER has soared while the mortgage price
has risen only modestly. That's because the mortgage interest
rate has plummeted, from nearly 13% in that year to less than
8% today. So even though house prices over this same period
have almost doubled, the monthly principal and interest payment
on the median-priced home is up by only 26%, compared with
93% for owner's equivalent rent.
My sour reaction to Robert Mundell's receiving the economics
Nobel prompted some readers to ask yet again just whom I
would deem worthy of receiving the award.
To begin with, assuming you scale down the enormous prestige
associated with the Nobel -- as I proposed, eliminating the $1
million in prize money would be a start -- Mundell was worthy
enough, and so was last year's winner, Amartya Sen. If the
whole idea is to give the award to any economist who has said a
few things worth remembering, then it's fairly easy to come up
with a list.
Three nominees of mine -- worth mentioning partly because they
have no chance of ever being considered -- would be Richard H.
Thaler, Thomas Sowell and Israel Kirzner. Thaler gets my nod
for his great work on the theory of "mental accounting" (see his
book, Quasi-Rational Economics); Sowell, for his insights on
economics and ethnicity (see The Economics and Politics of
Race), and Kirzner, for his seminal essays on entrepreneurship
(see Discovery and the Capitalist Process).
|
