Housing price volatility explained

Have you wondered why housing prices have crashed in some cities but not others. Law professor Todd Zywicki of George Mason University has been studying the issue and, as Forbes explains, found that, for housing markets, there are three types of cities:

His research has revealed three distinct types of housing markets--and only one of the three shows real signs of distress. Even then, that distress is only in a limited number of areas.

The first type of market behaves the way markets are supposed to behave, with smooth adjustments between supply and demand. When prices rose in places such as Dallas and Charlotte, builders constructed new houses. When prices softened, builders stopped. "Prices in these markets rose gradually," Zywicki says, "and now they're settling back to earth. There hasn't been any tragedy."

The second type of market, which appears in New York, Boston, San Francisco and Washington, D.C., demonstrates a long history of price volatility. "The housing stock in these markets is constrained," Zywicki says, "either by geography--San Francisco is surrounded on three sides by water, for example--or land use controls." When demand in such a market increases, prices soar. And when demand weakens, prices plummet.

"But the people who live in these markets expect big price swings," Zywicki says. "They've learned to live with them. They're holding onto their homes because they're confident prices will eventually recover. Again, there hasn't been any tragedy."

The third type of market displays both the ability to expand the supply of houses that characterizes the first type of market and the price swings that characterize the second type. "Type three markets," Zywicki says, "are concentrated in the Sun Belt. Ordinary investors seem to have calculated that a lot of people would either retire or buy second homes in these places. And when prices went up, speculators moved in. Pure bubbles developed."

In type three markets, hundreds of thousands of new homes went up. This oversupply will now keep prices low for years. "Las Vegas, Phoenix, Tampa--those are the places you'll find the tragedies," Zywicki says.

Hat tip: Instapundit.

What to do about housing?  So far, Obama's economic policy have been to reward people/companies with poor judgment by bailing them out using money taxed from those with good judgment.  Time will tell how well this plan works.