Brad DeLong and Angry Bear (here and here) make some very sensible observations about the whole housing bubble issue: Housing prices should be high when interest rates are low. The AB post references this article by Bruce Bartlett, highlighting the central point:
The rise in housing prices, here and elsewhere, is not surprising, given the decline in interest rates. Housing prices are, to a certain extent, like bond prices. When interest rates fall, bond prices rise. But, when interest rates rise, bond prices fall.
One of the central propositions of housing-bubble proponents is that price-rent ratios -- the analog to price-earnings ratios for equities -- are high by historical standards. DeLong interjects the right (in my opinion) perspective on this observation.
When interest rates go down, the same mortgage payment supports a greater amount borrowed, and homebuyers can mobilize more (current) buying power without pushing closer to the margin on their (long-run, future) income. You wouldn't expect the price-rental ratio to stay the same when interest rates went down--you would expect it to rise.
By how much should the price-rental ratio rise? And has it risen too much? Ah! That is a good question that depends on the "duration" of housing considered as an asset. I don't know. But I do know that the ratio of 30-year mortgage payments to rents is much more likely to be a useful indicator than the raw ratio of house prices to rents.
Exactly!