

House Prices Have Soared, But You Wouldn't Know It From the CPI

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O ver 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.

M y 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 ).