Ranch houses on fire.(prices and rates)

Here we are, full circle. A quarter century ago, I wrote a piece for The New Republic about soaring home prices. The cover featured a cartoon of a husband and wife entering a dinner party, the husband saying under his breath, "When they start talking real estate, let's leave."

They're talking real estate again, and no wonder. USA Today recently reported on a community in San Jose called Friendly Woods, where a modest ranch house cost $17,600 in 1963. Recently, an immigrant couple from India beat 25 other bidders to purchase the same house for $880,000.

In June, total sales of new and existing homes nationwide set all-time records, and median prices rose at an annual rate of 14.7 percent--the fastest increase since November 1980. But back then, inflation was 12 percent, so the actual jump was just a few percentage points. Today, with inflation under 3 percent, the real annual increase was around 12 percent. That is gigantic.

It's easy, at a time like this, to forget that home prices have a history of stability. Between 1975 and 2003, average home prices rose an average of less than 1 percent yearly (after inflation) in 29 states, and between 1 and 2 percent in 11 other states. At the same time, U.S. home prices overall have never declined since 1950. By contrast, even a broadly diversified portfolio of stocks like the Standard & Poor's 500 Index has dropped in 12 different years since 1950, and Treasury bonds fell in 16 specific years.

So what's going on with real estate prices today? First and foremost, interest rates are low--averaging 5.5 percent on a 30-year mortgage. My first mortgage in 1981 was 14 percent! At 5.5 percent, the monthly mortgage payment on the average-priced home ($219,000 as of June) was $1,243--eminently affordable for the typical two-earner American family.

If rates rise, will home prices fall? Possibly, but more likely they will level off, or not rise so much. Some of today's chitchat makes an analogy between the stock bubble of the 1990s and high home prices today. But there's a big difference. Homeowners won't stampede out of their houses. Where would they live? Higher rates will simply slow down the rate of new purchases. Even if prices do fall in some markets, the decline will be meaningless to most homeowners--who will continue to pay ...