Arnold on deflating the housing bubble

Recently, I tried to think through what deflating the housing bubble would actually mean. I suggested that it woul require prices to fall back to historic norms.

Arnold Kling disagrees.

I'm sorry, but unless by "some areas" you mean areas the size of a 9-digit zip code, we're not going to see 40 percent declines in house prices.

Think of the equilibrium house price as the equilibrium rent times the equilibrium price/rent ratio. I do not see rents falling in real terms. Housing starts are below the level needed to keep supply in line with new household formation, especially in an economy with relatively low unemployment. So, if anything, rents are going to be drifting up.

I like thinking in terms of price/rent ratios, and currently they are way out of whack to historic norms. Arnold takes a "first principles" approach and comes up with a ratio of 300x. Arnold takes this to conclude that real estate is cheap today, even after all the recent appreciation.

But what of historic price/rent ratios (which were certainly not 300x)? Arnold says:

I think there is nothing sacred about historical P/E ratios, for either stocks or houses. For stocks, the realized real returns over the past 100 years have been quite high, which suggests that traditional P/E ratios were too low. I think that the same is true for houses, although to a lesser extent.

I guess this would put him in the "permanently on a higher plateau" camp.