[The original version of this chapter was published as “Is the Housing Bubble Popping?” LewRockwell.com, August 8, 2005.]

Friday, August 5, 2005, was a bad day for housing stocks and this could be a sign that the housing bubble may have sprung its first leak. This is what the Philadelphia Stock Exchange Housing Sector Index looked like this week — losing about 5 percent for the week.

Investors have made around 50 percent on their money since I first reported on the housing bubble,Mark Thornton, “Housing: Too Good to Be True,” Mises Daily, June 4, 2004. and there could very well be more bubblingto come. In this graph of high-flying Toll Brothers (TOL), one of the largest home-building companies. The stock has increased by over 50 percent in the last year. Optimists point to the company’s price-to-earnings ratio of “only” fifteen, which is below the market average.

The pessimist’s case for a bursting or deflating of the housing bubble is the issue of rising interest rates. As Greenspan increases short-term interest rates it causes problems for those who have variable-rate mortgages tied to short-term interest rates. Energy prices and a slowdown in the economy can also dampen enthusiasm in the housing sector.

The larger problem may be for long-term rates because they are the foundation for fixed mortgage rates. As Greenspan increases short-term rates the thinking goes that he is reducing inflation expectations and thus reducing the likelihood of increases in long-term rates. However, if long-term rates rise, this is an indication that short-term rates are not rising fast enough to dampen inflationary price pressures.

Long-term interest rates are rising and there was a big increase in the interest rate on ten-year Treasury bonds on Friday, August 5th that coincided with the fall in home-builder stocks. Over the last summer this interest rate made a “double bottom” at about 3.9% which is almost the lowest it has been in my lifetime. It is now 4.4% and probably headed higher. [Note: it was 5.25% a year later.]

A double bottom is a term from technical stock analysis that is a bullish indicator, which in this case predicts higher long-term interest rates. Higher rates spell trouble for the home builders and give some indication the housing bubble might be coming to an end.

Hopefully, Alan Greenspan will know the correct lever to pull next. He did in the 1960s.Ron Paul, “Ron Paul vs. Alan Greenspan.” Testimony before the House Financial Affairs Committee, July 20, 2005.

Postscript If you look at a long-term chart of the Philadelphia Stock Exchange Housing Sector Index (symbol HGX) you will see that this was indeed the exact turning point for home-builder stocks, which typically lead the actual housing market. The Taylor rule, a guide to monetary policy, can also be said to have predicted the housing bubble ∕ financial crisis. WoodsThomas E. Woods, Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse (Washington, DC: Regnery Publishing, 2009). is the best analysis of the housing bubble, financial crisis, and the policy response to it.