Here's why experts believe the U.S. is in a housing boom and not a bubble
The U.S. housing market has been an unlikely beneficiary from the Covid-19 pandemic.
During the pandemic, home prices have climbed at a record pace. The median price for an existing home reached over $363,000 in June 2021, a 23.4% year-over-year increase.
"You can see in just basically the last 15 months or so, we've seen a dramatic acceleration in home price growth to levels we haven't seen in decades," CoreLogic chief economist Frank Nothaft said.
However, according to most experts, the market is shaping up to look more like a boom rather than a bubble.
"We say bubble because we can't believe how much prices have gone up," CNBC real estate correspondent Diana Olick said. "A bubble tends to be something that's inflated that could burst at any minute and change and that's not really the case here."
While speculation certainly is a factor, the main cause for the current housing demand is low mortgage rates. At the start of the pandemic in March 2020, the 30-year fixed-rate mortgage rate sat at 3.45%. By July of this year, that number had dropped to 2.87%.
Supply is also an issue. According to the National Association of Realtors, the U.S. has underbuilt its housing needs by at least 5.5 million units over the past 20 years. That's a stark comparison to the previous housing bubble in 2008 when overbuilding was the issue.
"So we've got a boost in demand that's due to record low mortgage rates and we've got a shrinkage of supply," Nothaft said. "So between more demand and less supply, prices are up and they're up at the fastest pace since the 1970s."
Watch the video to find out more about the U.S. housing market and whether it's in a bubble.
United States housing bubble
The United States housing bubble was a real estate bubble affecting over half of the U.S. states. It was the impetus for the subprime mortgage crisis. Housing prices peaked in early 2006, started to decline in 2006 and 2007, and reached new lows in 2012. On December 30, 2008, the Case–Shiller home price index reported its largest price drop in its history. The credit crisis resulting from the bursting of the housing bubble is an important cause of the Great Recession in the United States.
Increased foreclosure rates in 2006–2007 among U.S. homeowners led to a crisis in August 2008 for the subprime, Alt-A, collateralized debt obligation (CDO), mortgage, credit, hedge fund, and foreign bank markets. In October 2007, the U.S. Secretary of the Treasury called the bursting housing bubble "the most significant risk to our economy".
Any collapse of the U.S. housing bubble has a direct impact not only on home valuations, but mortgage markets, home builders, real estate, home supply retail outlets, Wall Street hedge funds held by large institutional investors, and foreign banks, increasing the risk of a nationwide recession. Concerns about the impact of the collapsing housing and credit markets on the larger U.S. economy caused President George W. Bush and the Chairman of the Federal ReserveBen Bernanke to announce a limited bailout of the U.S. housing market for homeowners who were unable to pay their mortgage debts.
In 2008 alone, the United States government allocated over $900 billion to special loans and rescues related to the U.S. housing bubble. This was shared between the public sector and the private sector. Because of the large market share of Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) (both of which are government-sponsored enterprises) as well as the Federal Housing Administration, they received a substantial share of government support, even though their mortgages were more conservatively underwritten and actually performed better than those of the private sector.
Land prices contributed much more to the price increases than did structures. This can be seen in the building cost index in Fig. 1. An estimate of land value for a house can be derived by subtracting the replacement value of the structure, adjusted for depreciation, from the home price. Using this methodology, Davis and Palumbo calculated land values for 46 U.S. metro areas, which can be found at the website for the Lincoln Institute for Land Policy.
Housing bubbles may occur in local or global real estate markets. In their late stages, they are typically characterized by rapid increases in the valuations of real property until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability. This may be followed by decreases in home prices that result in many owners finding themselves in a position of negative equity—a mortgage debt higher than the value of the property. The underlying causes of the housing bubble are complex. Factors include tax policy (exemption of housing from capital gains), historically low interest rates, lax lending standards, failure of regulators to intervene, and speculative fever. This bubble may be related to the stock market or dot-com bubble of the 1990s. This bubble roughly coincides with the real estate bubbles of the United Kingdom, Hong Kong, Spain, Poland, Hungary and South Korea.
While bubbles may be identifiable in progress, bubbles can be definitively measured only in hindsight after a market correction, which began in 2005–2006 for the U.S. housing market. Former U.S. Federal Reserve Board Chairman Alan Greenspan said "We had a bubble in housing", and also said in the wake of the subprime mortgage and credit crisis in 2007, "I really didn't get it until very late in 2005 and 2006." In 2001, Alan Greenspan dropped interest rates to a low 1% in order to jump the economy after the ".com" bubble. It was then bankers and other Wall Street firms started borrowing money due to its inexpensiveness.
The mortgage and credit crisis was caused by the inability of a large number of home owners to pay their mortgages as their low introductory-rate mortgages reverted to regular interest rates. Freddie Mac CEO Richard Syron concluded, "We had a bubble", and concurred with Yale economist Robert Shiller's warning that home prices appear overvalued and that the correction could last years, with trillions of dollars of home value being lost. Greenspan warned of "large double digit declines" in home values "larger than most people expect".
Problems for home owners with good credit surfaced in mid-2007, causing the United States' largest mortgage lender, Countrywide Financial, to warn that a recovery in the housing sector was not expected to occur at least until 2009 because home prices were falling "almost like never before, with the exception of the Great Depression". The impact of booming home valuations on the U.S. economy since the 2001–2002 recession was an important factor in the recovery, because a large component of consumer spending was fueled by the related refinancing boom, which allowed people to both reduce their monthly mortgage payments with lower interest rates and withdraw equity from their homes as their value increased.
Main article: Timeline of the United States housing bubble
Although an economic bubble is difficult to identify except in hindsight, numerous economic and cultural factors led several economists (especially in late 2004 and early 2005) to argue that a housing bubble existed in the U.S.Dean Baker identified the bubble in August 2002, thereafter repeatedly warning of its nature and depth, and the political reasons it was being ignored. Prior to that, Robert Prechter wrote about it extensively as did Professor Shiller in his original publication of Irrational Exuberance in the year 2000.
The burst of the housing bubble was predicted by a handful of political and economic analysts, such as Jeffery Robert Hunn in a March 3, 2003, editorial. Hunn wrote:
[W]e can profit from the collapse of the credit bubble and the subsequent stock market divestment [(decline)]. However, real estate has not yet joined in a decline of prices fed by selling (and foreclosing). Unless you have a very specific reason to believe that real estate will outperform all other investments for several years, you may deem this prime time to liquidate investment property (for use in more lucrative markets).
Many contested any suggestion that there could be a housing bubble, particularly at its peak from 2004 to 2006, with some rejecting the "house bubble" label in 2008. Claims that there was no warning of the crisis were further repudiated in an August 2008 article in The New York Times, which reported that in mid-2004 Richard F. Syron, the CEO of Freddie Mac, received a memo from David Andrukonis, the company's former chief risk officer, warning him that Freddie Mac was financing risk-laden loans that threatened Freddie Mac's financial stability. In his memo, Mr. Andrukonis wrote that these loans "would likely pose an enormous financial and reputational risk to the company and the country". The article revealed that more than two-dozen high-ranking executives said that Mr. Syron had simply decided to ignore the warnings.
Other cautions came as early as 2001, when the late Federal Reserve governor Edward Gramlich warned of the risks posed by subprime mortgages. In September 2003, at a hearing of the House Financial Services Committee, Congressman Ron Paul identified the housing bubble and foretold the difficulties it would cause: "Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss."Reuters reported in October 2007 that a Merrill Lynch analyst too had warned in 2006 that companies could suffer from their subprime investments.
The Economist magazine stated, "The worldwide rise in house prices is the biggest bubble in history", so any explanation needs to consider its global causes as well as those specific to the United States. The then Federal Reserve Board Chairman Alan Greenspan said in mid-2005 that "at a minimum, there's a little 'froth' (in the U.S. housing market) ... it's hard not to see that there are a lot of local bubbles"; Greenspan admitted in 2007 that froth "was a euphemism for a bubble". In early 2006, President Bush said of the U.S. housing boom: "If houses get too expensive, people will stop buying them ... Economies should cycle".
Throughout the bubble period there was little if any mention of the fact that housing in many areas was (and still is) selling for well above replacement cost.
On the basis of 2006 market data that were indicating a marked decline, including lower sales, rising inventories, falling median prices and increased foreclosure rates, some economists have concluded that the correction in the U.S. housing market began in 2006. A May 2006 Fortune magazine report on the US housing bubble states: "The great housing bubble has finally started to deflate ... In many once-sizzling markets around the country, accounts of dropping list prices have replaced tales of waiting lists for unbuilt condos and bidding wars over humdrum three-bedroom colonials."
The chief economist of Freddie Mac and the director of Joint Center for Housing Studies (JCHS) denied the existence of a national housing bubble and expressed doubt that any significant decline in home prices was possible, citing consistently rising prices since the Great Depression, an anticipated increased demand from the Baby Boom generation, and healthy levels of employment. However, some have suggested that the funding received by JCHS from the real estate industry may have affected their judgment.David Lereah, former chief economist of the National Association of Realtors (NAR), distributed "Anti-Bubble Reports" in August 2005 to "respond to the irresponsible bubble accusations made by your local media and local academics".
Among other statements, the reports stated that people "should [not] be concerned that home prices are rising faster than family income", that "there is virtually no risk of a national housing price bubble based on the fundamental demand for housing and predictable economic factors", and that "a general slowing in the rate of price growth can be expected, but in many areas inventory shortages will persist and home prices are likely to continue to rise above historic norms". Following reports of rapid sales declines and price depreciation in August 2006, Lereah admitted that he expected "home prices to come down 5% nationally, more in some markets, less in others. And a few cities in Florida and California, where home prices soared to nose-bleed heights, could have 'hard landings'."
National home sales and prices both fell dramatically in March 2007 — the steepest plunge since the 1989 Savings and Loan crisis. According to NAR data, sales were down 13% to 482,000 from the peak of 554,000 in March 2006, and the national median price fell nearly 6% to $217,000 from a peak of $230,200 in July 2006.
John A. Kilpatrick from Greenfield Advisors was cited by Bloomberg News on June 14, 2007, on the linkage between increased foreclosures and localized housing price declines: "Living in an area with multiple foreclosures can result in a 10 percent to 20 percent decrease in property values". He went on to say, "In some cases that can wipe out the equity of homeowners or leave them owing more on their mortgage than the house is worth. The innocent houses that just happen to be sitting next to those properties are going to take a hit."
The US SenateBanking Committee held hearings on the housing bubble and related loan practices in 2006, titled "The Housing Bubble and its Implications for the Economy" and "Calculated Risk: Assessing Non-Traditional Mortgage Products". Following the collapse of the subprime mortgage industry in March 2007, Senator Chris Dodd, Chairman of the Banking Committee held hearings and asked executives from the top five subprime mortgage companies to testify and explain their lending practices. Dodd said that "predatory lending" had endangered home ownership for millions of people. In addition, Democratic senators such as Senator Charles Schumer of New York were already proposing a federal government bailout of subprime borrowers in order to save homeowners from losing their residences.
Main article: Causes of the United States housing bubble
Home price appreciation has been non-uniform to such an extent that some economists, including former FedChairmanAlan Greenspan, have argued that United States was not experiencing a nationwide housing bubble per se, but a number of local bubbles. However, in 2007 Greenspan admitted that there was in fact a bubble in the U.S. housing market, and that "all the froth bubbles add up to an aggregate bubble".
Despite greatly relaxed lending standards and low interest rates, many regions of the country saw very little price appreciation during the "bubble period". Out of 20 largest metropolitan areas tracked by the S&P/Case-Shillerhouse price index, six (Dallas, Cleveland, Detroit, Denver, Atlanta, and Charlotte) saw less than 10% price growth in inflation-adjusted terms in 2001–2006. During the same period, seven metropolitan areas (Tampa, Miami, San Diego, Los Angeles, Las Vegas, Phoenix, and Washington, D.C.) appreciated by more than 80%.
However, housing bubbles did not manifest themselves in each of these areas at the same time. San Diego and Los Angeles had maintained consistently high appreciation rates since late 1990s, whereas the Las Vegas and Phoenix bubbles did not develop until 2003 and 2004 respectively. It was in the East Coast, the more populated part of the country where the economic real estate turmoil was the worst.
Somewhat paradoxically, as the housing bubble deflates some metropolitan areas (such as Denver and Atlanta) have been experiencing high foreclosure rates, even though they did not see much house appreciation in the first place and therefore did not appear to be contributing to the national bubble. This was also true of some cities in the Rust Belt such as Detroit and Cleveland, where weak local economies had produced little house price appreciation early in the decade but still saw declining values and increased foreclosures in 2007. As of January 2009 California, Michigan, Ohio and Florida were the states with the highest foreclosure rates.
By July 2008, year-to-date prices had declined in 24 of 25 U.S. metropolitan areas, with California and the southwest experiencing the greatest price falls. According to the reports, only Milwaukee had seen an increase in house prices after July 2007.
Prior to the real estate market correction of 2006–2007, the unprecedented increase in house prices starting in 1997 produced numerous wide-ranging effects in the economy of the United States.
- One of the most direct effects was on the construction of new houses. In 2005, 1,283,000 new single-family houses were sold, compared with an average of 609,000 per year during 1990–1995. The largest home builders, such as D. R. Horton, Pulte, and Lennar, saw their largest share prices and revenues in 2004–2005. D. R. Horton's stock went from $3 in early 1997 to all-time high of $42.82 on July 20, 2005. Pulte Corp's revenues grew from $2.33 billion in 1996 to $14.69 billion in 2005.
- Mortgage equity withdrawals – primarily home equity loans and cash out refinancings – grew considerably since the early 1990s. According to US Federal Reserve estimates, in 2005 homeowners extracted $750 billion of equity from their homes (up from $106 billion in 1996), spending two thirds of it on personal consumption, home improvements, and credit card debt.
- It is widely believed that the increased degree of economic activity produced by the expanding housing bubble in 2001–2003 was partly responsible for averting a full-scale recession in the U.S. economy following the dot-com bust and offshoring to China. Analysts believed that with the downturn in the two sectors, the economy from the early 2000s to 2007 evaded what would have been stagnant growth with a booming housing market creating jobs, economic demand along with a consumer boom that came from home value withdraws until the housing market began a correction.
- Rapidly growing house prices and increasing price gradients forced many residents to flee the expensive centers of many metropolitan areas, resulting in the explosive growth of exurbs in some regions. The population of Riverside County, California almost doubled from 1,170,413 in 1990 to 2,026,803 in 2006, due to its relative proximity to San Diego and Los Angeles. On the East Coast, Loudoun County, Virginia, near Washington, D.C., saw its population triple between 1990 and 2006.
- Extreme regional differences in land prices. The differences in housing prices are mainly due to differences in land values, which reached 85% of the total value of houses in the highest priced markets at the peak. The Wisconsin Business School publishes an on line database with building cost and land values for 46 U.S. metro areas. One of the fastest-growing regions in the United States for the last several decades was the Atlanta, Georgia metro area, where land values are a small fraction of those in the high-priced markets. High land values contribute to high living costs in general and are part of the reason for the decline of the old industrial centers while new automobile plants, for example, were built throughout the South, which grew in population faster than the other regions.
- People who either experienced foreclosures or live near foreclosures have a higher probability of falling ill or at the very least dealing with increased anxiety. Overall, it is reported that homeowners who are unable to afford living in their desired locations experience higher instances of poor health. Besides health issues, the unstable housing market has also been shown to increase instances of violence. They subsequently begin to fear that their own homes may be taken from them. Increases in anxiety have at the very least been commonly noted. There is a fear that foreclosures bring about these reactions in people who anticipate the same thing happening to them. An uptick on violent occurrences has also been shown to follow neighborhoods where such uncertainty exists.
These trends were reversed during the real estate market correction of 2006–2007. As of August 2007, D.R. Horton's and Pulte Corp's shares had fallen to 1/3 of their respective peak levels as new residential home sales fell. Some of the cities and regions that had experienced the fastest growth during 2000–2005 began to experience high foreclosure rates. It was suggested that the weakness of the housing industry and the loss of the consumption that had been driven by the withdrawal of mortgage equity could lead to a recession, but as of mid-2007 the existence of this recession had not yet been ascertained. In March 2008, Thomson Financial reported that the "Chicago Federal Reserve Bank's National Activity Index for February sent a signal that a recession [had] probably begun".
The share prices of Fannie Mae and Freddie Mac plummeted in 2008 as investors worried that they lacked sufficient capital to cover the losses on their $5 trillion portfolio of loans and loan guarantees. On June 16, 2010, it was announced that Fannie Mae and Freddie Mac would be delisted from the New York Stock Exchange; shares now trade on the over-the-counter market.
Housing market correction
Main article: United States housing market correction
Comparison of the percentage change in the Case-Shiller Home Price Indexfor the housing corrections in the periods beginning in 2005 (red) and the 1980s–1990s (blue), comparing monthly CSIvalues with the peak values immediately prior to the first month of decline all the way through the downturn and the full recovery of home prices.
Basing their statements on historic U.S. housing valuation trends, in 2005 and 2006 many economists and business writers predicted market corrections ranging from a few percentage points to 50% or more from peak values in some markets, and although this cooling had not yet affected all areas of the U.S., some warned that it still could, and that the correction would be "nasty" and "severe". Chief economist Mark Zandi of the economic research firm Moody's Economy.com predicted a "crash" of double-digit depreciation in some U.S. cities by 2007–2009. In a paper he presented to a Federal Reserve Board economic symposium in August 2007, Yale University economist Robert Shiller warned, "The examples we have of past cycles indicate that major declines in real home prices—even 50 percent declines in some places—are entirely possible going forward from today or from the not-too-distant future."
To better understand how the mortgage crisis played out, a 2012 report from the University of Michigan analyzed data from the Panel Study of Income Dynamics (PSID), which surveyed roughly 9,000 representative households in 2009 and 2011. The data seem to indicate that, while conditions are still difficult, in some ways the crisis is easing: Over the period studied, the percentage of families behind on mortgage payments fell from 2.2 to 1.9; homeowners who thought it was "very likely or somewhat likely" that they would fall behind on payments fell from 6% to 4.6% of families. On the other hand, family's financial liquidity has decreased: "As of 2009, 18.5% of families had no liquid assets, and by 2011 this had grown to 23.4% of families."
By mid-2016, the national housing price index was "about 1 percent shy of that 2006 bubble peak" in nominal terms but 20% below in inflation adjusted terms.
Subprime mortgage industry collapse
Main article: Subprime mortgage crisis
In March 2007, the United States' subprime mortgage industry collapsed due to higher-than-expected home foreclosure rates (no verifying source), with more than 25 subprime lenders declaring bankruptcy, announcing significant losses, or putting themselves up for sale. The stock of the country's largest subprime lender, New Century Financial, plunged 84% amid Justice Department investigations, before ultimately filing for Chapter 11 bankruptcy on April 2, 2007, with liabilities exceeding $100 million.
The manager of the world's largest bond fund, PIMCO, warned in June 2007 that the subprime mortgage crisis was not an isolated event and would eventually take a toll on the economy and ultimately have an impact in the form of impaired home prices.Bill Gross, a "most reputable financial guru", sarcastically and ominously criticized the credit ratings of the mortgage-based CDOs now facing collapse:
AAA? You were wooed, Mr. Moody's and Mr. Poor's, by the makeup, those six-inch hooker heels, and a "tramp stamp." Many of these good-looking girls are not high-class assets worth 100 cents on the dollar ... [T]he point is that there are hundreds of billions of dollars of this toxic waste ... This problem [ultimately] resides in America's heartland, with millions and millions of overpriced homes.
Business Week has featured predictions by financial analysts that the subprime mortgage market meltdown would result in earnings reductions for large Wall Street investment banks trading in mortgage-backed securities, especially Bear Stearns, Lehman Brothers, Goldman Sachs, Merrill Lynch, and Morgan Stanley. The solvency of two troubled hedge funds managed by Bear Stearns was imperiled in June 2007 after Merrill Lynch sold off assets seized from the funds and three other banks closed out their positions with them. The Bear Stearns funds once had over $20 billion of assets, but lost billions of dollars on securities backed by subprime mortgages.
H&R Block reported that it had made a quarterly loss of $677 million on discontinued operations, which included the subprime lender Option One, as well as writedowns, loss provisions for mortgage loans and the lower prices achievable for mortgages in the secondary market. The unit's net asset value had fallen 21% to $1.1 billion as of April 30, 2007. The head of the mortgage industry consulting firm Wakefield Co. warned, "This is going to be a meltdown of unparalleled proportions. Billions will be lost." Bear Stearns pledged up to U.S. $3.2 billion in loans on June 22, 2007, to bail out one of its hedge funds that was collapsing because of bad bets on subprime mortgages.
Peter Schiff, president of Euro Pacific Capital, argued that if the bonds in the Bear Stearns funds were auctioned on the open market, much weaker values would be plainly revealed. Schiff added, "This would force other hedge funds to similarly mark down the value of their holdings. Is it any wonder that Wall street is pulling out the stops to avoid such a catastrophe? ... Their true weakness will finally reveal the abyss into which the housing market is about to plummet." The New York Times report connects the hedge fund crisis with lax lending standards: "The crisis this week from the near collapse of two hedge funds managed by Bear Stearns stems directly from the slumping housing market and the fallout from loose lending practices that showered money on people with weak, or subprime, credit, leaving many of them struggling to stay in their homes."
On August 9, 2007, BNP Paribas announced that it could not fairly value the underlying assets in three funds because of its exposure to U.S. subprime mortgage lending markets. Faced with potentially massive (though unquantifiable) exposure, the European Central Bank (ECB) immediately stepped in to ease market worries by opening lines of €96.8 billion (U.S. $130 billion) of low-interest credit. One day after the financial panic about a credit crunch had swept through Europe, the U.S. Federal Reserve Bank conducted an "open market operation" to inject U.S. $38 billion in temporary reserves into the system to help overcome the ill effects of a spreading credit crunch, on top of a similar move the previous day. In order to further ease the credit crunch in the U.S. credit market, at 8:15 a.m. on August 17, 2007, the chairman of the Federal Reserve Bank Ben Bernanke decided to lower the discount window rate, which is the lending rate between banks and the Federal Reserve Bank, by 50 basis points to 5.75% from 6.25%. The Federal Reserve Bank stated that the recent turmoil in the U.S. financial markets had raised the risk of an economic downturn.
In the wake of the mortgage industry meltdown, Senator Chris Dodd, chairman of the Banking Committee, held hearings in March 2007 in which he asked executives from the top five subprime mortgage companies to testify and explain their lending practices. Dodd said that "predatory lending practices" were endangering home ownership for millions of people. In addition, Democratic senators such as Senator Charles Schumer of New York were already proposing a federal government bailout of subprime borrowers like the bailout made in the savings and loan crisis, in order to save homeowners from losing their residences. Opponents of such a proposal[who?] asserted that a government bailout of subprime borrowers was not in the best interests of the U.S. economy because it would simply set a bad precedent, create a moral hazard, and worsen the speculation problem in the housing market.
Lou Ranieri of Salomon Brothers, creator of the mortgage-backed securities market in the 1970s, warned of the future impact of mortgage defaults: "This is the leading edge of the storm ... If you think this is bad, imagine what it's going to be like in the middle of the crisis." In his opinion, more than $100 billion of home loans were likely to default when the problems seen in the subprime industry also emerge in the prime mortgage markets.
Former Federal Reserve Chairman Alan Greenspan had praised the rise of the subprime mortgage industry and the tools which it uses to assess credit-worthiness in an April 2005 speech. Because of these remarks, as well as his encouragement of the use of adjustable-rate mortgages, Greenspan has been criticized for his role in the rise of the housing bubble and the subsequent problems in the mortgage industry that triggered the economic crisis of 2008. On October 15, 2008, Anthony Faiola, Ellen Nakashima and Jill Drew wrote a lengthy article in the Washington Post titled, "What Went Wrong". In their investigation, the authors claim that Greenspan vehemently opposed any regulation of financial instruments known as derivatives. They further claim that Greenspan actively sought to undermine the office of the Commodity Futures Trading Commission, specifically under the leadership of Brooksley E. Born, when the Commission sought to initiate the regulation of derivatives. Ultimately, it was the collapse of a specific kind of derivative, the mortgage-backed security, that triggered the economic crisis of 2008. Concerning the subprime mortgage mess, Greenspan later admitted that "I really didn't get it until very late in 2005 and 2006."
On September 13, 2007, the British bank Northern Rock applied to the Bank of England for emergency funds because of liquidity problems related to the subprime crisis. This precipitated a bank run at Northern Rock branches across the UK by concerned customers who took out "an estimated £2bn withdrawn in just three days".
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Is a housing market crash on the way in 2021?
With the real estate market experiencing surging prices, scant inventories, and a backlog of new home construction, many consumers are wondering if what’s gone up must come back down — in other words, are we headed for another housing market crash? Let’s take a closer look.
Memories of the Great Recession Are Still Fresh
Few people foresaw the housing market crash 15 years ago that ignited a worldwide recession. Fueled by low interest rates, loose mortgage lending standards, and the nation’s unshakeable faith in homeownership, home values rose at record rates year after year. When the housing bubble burst, some nine million families lost their homes to foreclosure or short sale between 2006 and 2014. Housing values plunged 30% or more, homeowners lost a collective $7 trillion, and it took nearly a decade for most markets to recover. Even today, several local real estate markets have not fully recovered.
READ ALSO: 5 Arizona housing market predictions for 2021
With the robust market activity we’ve seen lately, are we in for a repeat housing market crash? The short answer is “not likely.” Today’s mini-boom cannot be sustained, but a crash as serious as the last one is highly unlikely because of a few determining factors:
Factor #1: Higher Lending Standards
Loose mortgage lending practices ultimately brought down some of the nation’s largest banks and mortgage companies. The fallout forced Congress and federal regulators to make significant adjustments that have since fundamentally changed how mortgage lending is regulated.
Since then, standards have been raised and the process of obtaining a mortgage is now more transparent. “Anyone can get one” types of loans are illegal, while borrowers must undergo rigorous income and asset checks. An entirely new regulatory agency, the Consumer Financial Protection Bureau, was created to enforce this new regulatory framework. Lenders who do not comply with these standards risk severe penalties.
As a result, the housing finance marketplace is now more robust and safe than it was 15 years ago. Any dip in the housing market will be cushioned by these stricter regulations.
Factor #2: Pandemic Mortgage Forbearance
When the housing market crashed in 2007, the influx of foreclosures pumped housing supply into areas with falling prices and weak labor markets, while also preventing recently-foreclosed borrowers from re-entering the market as buyers. According to the Federal Reserve, foreclosures during a time of high unemployment could depress prices, plunging homeowners across the country deeper into negative equity.
However, in the pandemic era, the effects of mass unemployment bear little resemblance to the Great Recession, thanks in large part to forbearance programs that have allowed homeowners to postpone their monthly mortgage payments without suffering penalties.
As of early March 2021, 2.6 million homeowners’ mortgages were in such forbearance plans. As the pandemic economy has slowly recovered, many homeowners have since resumed their employment, and thus their home payments. According to CoreLogic, by the end of 2020, overall mortgage delinquencies declined 5.8% due to the forbearance program. The share of mortgages 60 to 89 days past due declined to 0.5%, lower than 0.6% in December 2019.
It’s worth noting, however, that serious delinquencies — defined as 90 days or more past due, including loans in foreclosure — increased when owners who owed large amounts left forbearance. By year end 2020, the serious delinquency rate was 3.9%, up from 1.2% in December 2019.
Inevitably, some owners in forbearance will fail to secure a loan modification or a lengthy repayment period from their lenders. Unless the government provides a bailout for these beleaguered owners, they will lose their homes when forbearances end. ATTOM Data Solutions expects at least 200,000 defaults in 2021 and a 70% increase in foreclosures over the subsequent two years ─ a significant increase from current levels, but a far cry from the 6 million foreclosures following the 2007 crash.
Factor #3: The Cushion of Homeowners’ Equity
Equity is the difference between the current market value of your home and the amount you owe on it. In other words, it’s the portion of your home’s value that you actually own. Equity can be an incentive to stay in your home longer; if prices rise — something we’ve seen almost universally across the country in recent months — your equity increases, too.
Why does this matter? Simply put, higher levels of equity cushion homeowners from default when home values fall.
Over the past decade, American homeowners have enjoyed housing stability and growth, building up large home equity reserves. In the third quarter of 2020, the average family with a mortgage had $194,000 in home equity, and the average homeowner gained approximately $26,300 in equity over the course of the year. In contrast, 2009 saw nearly a quarter of the nation’s mortgaged homes valued for less than the amount their owners actually owed on those mortgages.
Factor #4: Price Growth Will Slow, But Not Stop
The sales boom following the outbreak of the COVID-19 pandemic in April 2020 surprised many real estate economists; like most other business sectors, real estate was expected (if not required in many locations) to lock down. But by mid-April, sales were soaring as buyers, many of them millennials, took advantage of record-low mortgage interest rates. Through the remainder of 2020, rates remained below 3%, and existing home sales reached their highest level in 14 years.
The combination of solid sales and depleted supplies drove the nation’s median existing-home price for all housing types to $309,800, up 12.9% from December 2019 and marking 106 straight months of year-over-year gains.
The multi-year run of significant price increases will end, at least temporarily, but inflationary pressure on entry-level homes will continue in most markets until new home construction will relieve it. Economists at Fannie Mae, Freddie Mac, the Mortgage Bankers Association, and the National Association of Realtors forecast median prices will rise between 3 to 8% in 2021, a significant drop from 2020 but nothing like the crash in prices seen in the last housing crash.
A Moving Target
While no one can say for sure what will happen with the real estate sector, most experts are confident that we’ll experience a market dip, but certainly not a crash. Still, it’s important to stay informed of market trends, consumer sentiments, and expert insights. Check back with Homes.com for all the latest!
type of economic bubble
A real-estate bubble or property bubble (or housing bubble for residential markets) is a type of economic bubble that occurs periodically in local or global real-estate markets, and typically follow a land boom. A land boom is the rapid increase in the market price of real property such as housing until they reach unsustainable levels and then decline. This period, during the run up to the crash, is also known as froth. The questions of whether real estate bubbles can be identified and prevented, and whether they have broader macroeconomic significance, are answered differently by schools of economic thought, as detailed below.
Bubbles in housing markets are more critical than stock market bubbles. Historically, equity price busts occur on average every 13 years, last for 2.5 years, and result in about 4 percent loss in GDP. Housing price busts are less frequent, but last nearly twice as long and lead to output losses that are twice as large (IMF World Economic Outlook, 2003). A recent laboratory experimental study also shows that, compared to financial markets, real estate markets involve longer boom and bust periods. Prices decline slower because the real estate market is less liquid.
The financial crisis of 2007–2008 was related to the bursting of real estate bubbles that had begun in various countries during the 2000s.
Identification and prevention
As with all types of economic bubbles, disagreement exists over whether or not a real estate bubble can be identified or predicted, then perhaps prevented. Speculative bubbles are persistent, systematic and increasing deviations of actual prices from their fundamental values. Real estate bubbles can be difficult to identify even as they are occurring, due in part to the difficulty of discerning the intrinsic value of real estate. As with other medium and long range economic trends, accurate prediction of future bubbles has proven difficult.
In real estate, fundamentals can be estimated from rental yields (where real estate is then considered in a similar vein to stocks and other financial assets) or based on a regression of actual prices on a set of demand and/or supply variables.
American economist Robert Shiller of the Case–Shiller Home Price Index of home prices in 20 metro cities across the United States indicated on May 31, 2011 that a "Home Price Double Dip [is] Confirmed" and British magazine The Economist, argue that housing market indicators can be used to identify real estate bubbles. Some[who?] argue further that governments and central banks can and should take action to prevent bubbles from forming, or to deflate existing bubbles.
A land value tax (LVT) can be introduced to prevent speculation on land. Real estate bubbles direct savings towards rent seeking activities rather than other investments. A land value tax removes financial incentives to hold unused land solely for price appreciation, making more land available for productive uses. At sufficiently high levels, land value tax would cause real estate prices to fall by removing land rents that would otherwise become 'capitalized' into the price of real estate. It also encourages landowners to sell or relinquish titles to locations that they are not using and thus stop speculators hoarding unused land.
Within mainstream economics, economic bubbles, and in particular real estate bubbles, are not considered major concerns.[dubious – discuss] Within some schools of heterodox economics, by contrast, real estate bubbles are considered of critical importance and a fundamental cause of financial crises and ensuing economic crises.
The pre-dominating economic perspective is that increases in housing prices result in little or no wealth effect, namely it does not affect the consumption behavior of households not looking to sell. The house price becoming compensation for the higher implicit rent costs for owning. Increasing house prices can have a negative effect on consumption through increased rent inflation and a higher propensity to save given expected rent increase.
In some schools of heterodox economics, notably Austrian economics and Post-Keynesian economics, real estate bubbles are seen as an example of credit bubbles (pejoratively,[clarification needed]speculative bubbles), because property owners generally use borrowed money to purchase property, in the form of mortgages. These are then argued to cause financial and hence economic crises. This is first argued empirically – numerous real estate bubbles have been followed by economic slumps, and it is argued that there is a cause-effect relationship between these.
The Post-Keynesian theory of debt deflation takes a demand-side view, arguing that property owners not only feel richer but borrow to (i) consume against the increased value of their property – by taking out a home equity line of credit, for instance; or (ii) speculate by buying property with borrowed money in the expectation that it will rise in value. When the bubble bursts, the value of the property decreases but not the level of debt. The burden of repaying or defaulting on the loan depresses aggregate demand, it is argued, and constitutes the proximate cause of the subsequent economic slump.
Housing market indicators
In attempting to identify bubbles before they burst, economists have developed a number of financial ratios and economic indicators that can be used to evaluate whether homes in a given area are fairly valued. By comparing current levels to previous levels that have proven unsustainable in the past (i.e. led to or at least accompanied crashes), one can make an educated guess as to whether a given real estate market is experiencing a bubble. Indicators describe two interwoven aspects of housing bubble: a valuation component and a debt (or leverage) component. The valuation component measures how expensive houses are relative to what most people can afford, and the debt component measures how indebted households become in buying them for home or profit (and also how much exposure the banks accumulate by lending for them). A basic summary of the progress of housing indicators for U.S. cities is provided by Business Week. See also: real estate economics and real estate trends.
Housing affordability measures
- The price to income ratio is the basic affordability measure for housing in a given area. It is generally the ratio of median house prices to median familial disposable incomes, expressed as a percentage or as years of income. It is sometimes compiled separately for first-time buyers and termed attainability. This ratio, applied to individuals, is a basic component of mortgage lending decisions. According to a back-of-the-envelope calculation by Goldman Sachs, a comparison of median home prices to median household income suggests that U.S. housing in 2005 was overvalued by 10%. "However, this estimate is based on an average mortgage rate of about 6%, and we expect rates to rise", the firm's economics team wrote in a recent[when?] report. According to Goldman's figures, a one-percentage-point rise in mortgage rates would reduce the fair value of home prices by 8%.
- The deposit to income ratio is the minimum required downpayment for a typical mortgage[specify], expressed in months or years of income. It is especially important for first-time buyers without existing home equity; if the down payment becomes too high then those buyers may find themselves "priced out" of the market. For example, as of 2004[update] this ratio was equal to one year of income in the UK.
Another variant is what the United States's National Association of Realtors calls the "housing affordability index" in its publications. (The soundness of the NAR's methodology was questioned by some analysts as it does not account for inflation. Other analysts,[who?] however, consider the measure appropriate, because both the income and housing cost data are expressed in terms that include inflation and, all things being equal, the index implicitly includes inflation).
- The affordability index measures the ratio of the actual monthly cost of the mortgage to take-home income. It is used more in the United Kingdom where nearly all mortgages are variable and pegged to bank lending rates. It offers a much more realistic measure of the ability of households to afford housing than the crude price to income ratio. However it is more difficult to calculate, and hence the price-to-income ratio is still more commonly used by pundits.[who?] In recent years,[when?] lending practices have relaxed, allowing greater multiples of income to be borrowed.
- The median multiple measures the ratio of the median house price to the median annual household income. This measure has historically hovered around a value of 3.0 or less, but in recent years[when?] has risen dramatically, especially in markets with severe public policy constraints on land and development.
Housing debt measures
- The housing debt to income ratio or debt-service ratio is the ratio of mortgage payments to disposable income. When the ratio gets too high, households become increasingly dependent on rising property values to service their debt. A variant of this indicator measures total home ownership costs, including mortgage payments, utilities and property taxes, as a percentage of a typical household's monthly pre-tax income; for example see RBC Economics' reports for the Canadian markets.
- The housing debt to equity ratio (not to be confused with the corporate debt to equity ratio), also called loan to value, is the ratio of the mortgage debt to the value of the underlying property; it measures financial leverage. This ratio increases when the homeowner takes a second mortgage or home equity loan using the accumulated equity as collateral. A ratio greater higher than 1 implies that owner's equity is negative.
Housing ownership and rent measures
- Bubbles can be determined when an increase in housing prices is higher than the rise in rents. In the US, rent between 1984 and 2013 has risen steadily at about 3% per year, whereas between 1997 and 2002 housing prices rose 6% per year. Between 2011 and the third-quarter of 2013 housing prices rose 5.83% and rent increased 2%.
- The ownership ratio is the proportion of households who own their homes as opposed to renting. It tends to rise steadily with incomes. Also, governments often enact measures such as tax cuts or subsidized financing to encourage and facilitate home ownership. If a rise in ownership is not supported by a rise in incomes, it can mean either that buyers are taking advantage of low interest rates (which must eventually rise again as the economy heats up) or that home loans are awarded more liberally, to borrowers with poor credit. Therefore, a high ownership ratio combined with an increased rate of subprime lending may signal higher debt levels associated with bubbles.
- The price-to-earnings ratio or P/E ratio is the common metric used to assess the relative valuation of equities. To compute the P/E ratio for the case of a rented house, divide the price of the house by its potential earnings or net income, which is the market annual rent of the house minus expenses, which include maintenance and property taxes. This formula is:
- The house price-to-earnings ratio provides a direct comparison with P/E ratios utilised to analyze other uses of the money tied up in a home. Compare this ratio to the simpler but less accurate price-rent ratio below.
- The price-rent ratio is the average cost of ownership divided by the received rent income (if buying to let) or the estimated rent (if buying to reside):
- The latter is often measured using the "owner's equivalent rent" numbers published by the Bureau of Labor Statistics. It can be viewed as the real estate equivalent of stocks' price-earnings ratio; in other terms it measures how much the buyer is paying for each dollar of received rent income (or dollar saved from rent spending). Rents, just like corporate and personal incomes, are generally tied very closely to supply and demand fundamentals; one rarely sees an unsustainable "rent bubble" (or "income bubble" for that matter). Therefore a rapid increase of home prices combined with a flat renting market can signal the onset of a bubble. The U.S. price-rent ratio was 18% higher than its long-run average as of October 2004.
- The gross rental yield, a measure used in the United Kingdom, is the total yearly gross rent divided by the house price and expressed as a percentage:
- This is the reciprocal of the house price-rent ratio. The net rental yield deducts the landlord's expenses (and sometimes estimated rental voids) from the gross rent before doing the above calculation; this is the reciprocal of the house P/E ratio.
- Because rents are received throughout the year rather than at its end, both the gross and net rental yields calculated by the above are somewhat less than the true rental yields obtained when taking into account the monthly nature of rental payments.
- The occupancy rate (opposite: vacancy rate) is the number of occupied housing units divided by the total number of units in a given region (in commercial real estate, usually expressed in terms of area (i.e. in square metres, acres, et cetera) for different grades of buildings). A low occupancy rate means that the market is in a state of oversupply brought about by speculative construction and purchase. In this context, supply-and-demand numbers can be misleading: sales demand exceeds supply, but rent demand does not.
Housing price indices
Main article: House price index
Measures of house price are also used in identifying housing bubbles; these are known as house price indices (HPIs).
A noted series of HPIs for the United States are the Case–Shiller indices, devised by American economists Karl Case, Robert J. Shiller, and Allan Weiss. As measured by the Case–Shiller index, the US experienced a housing bubble peaking in the second quarter of 2006 (2006 Q2).
Recent real estate bubbles
The crash of the Japanese asset price bubble from 1990 on has been very damaging to the Japanese economy. The crash in 2005 affected Shanghai, China's largest city.
As of 2007[update], real estate bubbles had existed in the recent past or were widely believed to still exist in many parts of the world. including Argentina,New Zealand, Ireland, Spain, Lebanon, Poland, and Croatia. Then U.S. Federal Reserve Chairman Alan Greenspan said in mid-2005 that "at a minimum, there's a little 'froth' (in the U.S. housing market) … it's hard not to see that there are a lot of local bubbles." The Economist magazine, writing at the same time, went further, saying "the worldwide rise in house prices is the biggest bubble in history".
In France, the economist Jacques Friggit publishes each year a study called "Evolution of the price, value and number of property sales in France since the 19th century", showing a high price increase since 2001. Yet, the existence of a real estate bubble in France is discussed by economists. Real estate bubbles are invariably followed by severe price decreases (also known as a house price crash) that can result in many owners holding mortgages that exceed the value of their homes. 11.1 million residential properties, or 23.1% of all U.S. homes, were in negative equity at December 31, 2010. Commercial property values remained around 35% below their mid-2007 peak in the United Kingdom. As a result, banks have become less willing to hold large amounts of property-backed debt, likely a key issue affecting the worldwide recovery in the short term.
By 2006, most areas of the world were thought to be in a bubble state, although this hypothesis, based upon the observation of similar patterns in real estate markets of a wide variety of countries, was subject to controversy. Such patterns include those of overvaluation and, by extension, excessive borrowing based on those overvaluations. The U.S. subprime mortgage crisis of 2007–2010, alongside its impacts and effects on economies in various nations, has implied that these trends might have some[which?] common characteristics.
For individual countries, see:
US real estate bubble 2012–present
This section needs to be updated. Please help update this article to reflect recent events or newly available information.(March 2020)
The Washington Post writer Lisa Sturtevant thinks that the housing market of 2013 was not indicative of a housing bubble. "A critical difference between the current market and the overheated market of the middle of last decade is the nature of the mortgage market. Stricter underwriting standards have limited the pool of potential homebuyers to those who are most qualified and most likely to be able to pay loans back. The demand this time is based more closely on market fundamentals. And the price growth we’ve experienced recently is 'real.' Or 'more real.'" Other recent research indicates that mid-level managers in securitized finance did not exhibit awareness of problems in overall housing markets.
Economist David Stockman believes that a second housing bubble was started in 2012 and still inflating as of February 2013. Housing inventory began to dwindle starting in early 2012 as hedge fund investors and private equity firms purchase single-family homes in hopes of renting them out while waiting for a housing rebound. Due to the policies of QE3, mortgage interest rates have been hovering at an all-time low, causing real estate values to rise. Home prices have risen unnaturally as much as 25% within one year in metropolitan areas like the San Francisco Bay Area and Las Vegas.
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- ^"Real estate prices in Adriatic Coast up, Zagreb down". Global Property Guide. August 19, 2008. Retrieved June 23, 2009.
- ^Leonhardt, David (December 25, 2005). "2005: In a Word: Frothy". New York Times. Retrieved June 23, 2009.
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- ^"The French housing market and its environment since 1800". Conseil Général de l'Environnement et du Développement Durable. Retrieved December 21, 2016.
- ^"Bulle immobilière : de quoi parle-t-on et que faut-il craindre ?". Ideal-investisseur. Retrieved December 21, 2016.
- ^Kellington, Tom (May 25, 2021). "What happens when real estate bubbles pop?". The Business Daily. Retrieved May 26, 2021.
- ^Philyaw, Jason (March 8, 2011). "Underwater mortgages back above 11 million in 4Q". CoreLogic. Retrieved April 14, 2014.
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- ^"Headlines in the financial press ranged from “Property slowdown fuels China fears” to “China property correction would be painful, but salutary” (Financial Times, 2014e, p. 3). Housing demand has been increasing due to higher incomes, rapid urbanization and China’s rural urban migration strategy"
- ^"The ups and downs of the real estate market and its relations with the rest of the economy in China". Real Estate, Construction and Economic Development in Emerging Market Economies. 2015. pp. 108–124. doi:10.4324/9781315762289-13. ISBN .
- ^Bajaj, Vikas; Leonhardt, David (December 18, 2008). "Tax Break May Have Helped Cause Housing Bubble". New York Times. Retrieved May 6, 2012.
- ^Sturtevant, Lisa A. (March 26, 2013). "Is the Washington, D.C.-area housing market bubbling again?". The Washington Post.
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- ^"This is Housing Bubble 2.0: David Stockman".
- ^StreetAuthority (January 15, 2013). "Why Blackstone Bought 16,000 Homes". SeekingAlpha.com. Retrieved January 6, 2017.
- ^"Comeback for California Housing Prices". NBCLosAngeles.com. Retrieved January 6, 2017.
- John Calverley (2004), Bubbles and how to survive them, N. Brealey. ISBN 1-85788-348-9
- Robert J. Shiller (2005). Irrational Exuberance, 2d ed. Princeton University Press. ISBN 0-691-12335-7.
- John R. Talbott (2003). The Coming Crash in the Housing Market, New York: McGraw-Hill, Inc. ISBN 0-07-142220-X.
- Andrew Tobias (2005). The Only Investment Guide You'll Ever Need (updated ed.), Harcourt Brace and Company. ISBN 0-15-602963-4.
- Eric Tyson (2003). Personal Finance for Dummies, 4th ed., Foster City, CA: IDG Books. ISBN 0-7645-2590-5.
- Burton G. Malkiel (2003). The Random Walk Guide to Investing: Ten Rules for Financial Success, New York: W. W. Norton and Company, Inc. ISBN 0-393-05854-9.
- Elizabeth Warren and Amelia Warren Tyagi (2003). The Two-Income Trap: Why Middle-Class Mothers and Fathers Are Going Broke, New York: Basic Books. ISBN 0-465-09082-6.
Market bubble housing
Home Prices Are Now Higher Than The Peak Of The 2000s Housing Bubble. What Gives?
Even before the pandemic pushed the U.S. housing market into overdrive, the price of the average American home was on a rocket ride, climbing more than 50% between 2012 and 2019. It was the third biggest housing boom in American history. Then came the pandemic, marked by a buying frenzy and a selling freeze, which created a supply-demand mismatch that made the price boom go into warp speed. The average price of American homes, in real terms, is now the highest it's ever been — even higher than the peak of the housing bubble in 2006 before it crashed 60% and bottomed out in 2012.
Now that home prices have surpassed the peak that preceded the 2000s housing crash, many people are worried. Are we in another bubble? Or maybe the housing bubble a couple decades ago wasn't really a bubble? If so, then why was there a crash?
A new study by economists Gabriel Chodorow-Reich, Adam M. Guren and Timothy J. McQuade helps to explain the dynamics of our bonkers housing market. It has the perfect title: "The 2000s Housing Cycle With 2020 Hindsight."
[Editor's note: This is an excerpt of Planet Money's newsletter. You can sign up here.]
They find evidence that the price surge in the 2000s was indeed a bubble, which serves as a scary reminder that the housing market can go wild and crash. But they also find evidence that may provide some comfort to homeowners: Something real can explain the long-run upward trend in home prices.
Economists define bubbles as when the prices of assets — such as stocks and houses — depart from their fundamentals. Fundamentals are what an asset is actually worth. A house's fundamental value includes things such as its proximity to good-paying jobs; whether it's in a locale with a nice climate or fun things to do; whether the school district is good; whether it has desirable characteristics, such as good square footage and an architectural style that's in vogue. Importantly, the fundamental value of a house is determined by the supply and demand for houses in a given area: If it's desirable to live in that area and there aren't enough homes for incoming residents, the fundamental value of each house will rise.
There's been a decades-long economic debate over if and why manias cause homes to depart from their fundamentals. One side believes that homebuyers and sellers are rational, effectively processing information about home fundamentals before they buy or sell. They believe housing bubbles are rare, or even impossible. The other side believes that quirks of human psychology lead homebuyers and sellers to misjudge the fundamental value of homes, leading to bubbles and crashes.
In this new study, the economists look backward, with 20/20 hindsight, and do lots of work to figure out what the fundamental value of homes really were. They look at factors such as job growth and amenities that increased housing demand in local markets around the nation. And they look at how hard it was to increase the supply of new homes in those areas to accommodate rising demand.
The economists find these fundamentals explain most of the long-run price growth in those areas. Not only that, they find that these fundamentals explain which places had the biggest booms, the biggest busts and the biggest rebounds. Chodorow-Reich, a Harvard University economist who co-authored the study, says these places were mostly the so-called superstar cities, which have seen roaring economic growth over the last few decades. "The fact that the largest long-run growth is in superstar cities, like San Francisco, Seattle, San Diego and Boston — places that have constrained supply, lots of growing industries and good jobs — suggests this was a fundamentals-driven cycle."
But if there was a real reason for prices to soar in these places, then why did these places see a bubble and crash? To explain this, Chodorow-Reich and his colleagues resurrect a theory of a long-dead economist, Charles Kindleberger.
The bubble theorist who led an amazing life
Kindleberger should probably have a Hollywood movie made about his life. During World War II, he worked for the Office of Strategic Services, the predecessor of the CIA. After the war, he was one of the brilliant minds behind the Marshall Plan, which helped rebuild Europe. Kindleberger then started researching and teaching at the Massachusetts Institute of Technology, producing a flurry of influential books and papers.
Kindleberger's most popular book was called Manias, Panics and Crashes. The book provides a sweeping history of financial crises, from the currency crisis in the Holy Roman Empire, to "tulipmania" in Holland, to the dot-com bubble in the late 1990s.
"The main thing we draw from that book is the idea that these boom-bust cycles start with some change in fundamentals," Chodorow-Reich says. For example, in the 19th century, America saw the invention and spread of steam-powered locomotives. Investors got excited about that, and rightly so: It was a technology that would make lots of money. When the United States started building the transcontinental railroad, the value of land around wherever there were train stops became more valuable. People could stop, shop, set up businesses and live more easily near there now.
But, in Kindleberger's theory, investors got over-excited about the economic changes the new technology brought about. They began seeing the sky as the limit. They over-speculated on land near railroad stops, often borrowing from banks and racking up debt in the process. At some point, reality kicked in, and prices began to fall. Once prices fell, investors couldn't pay their debts, and that led to a crisis. It's a general pattern he finds repeated over and over in history.
Chodorow-Reich and his colleagues see something similar in the boom and bust in the U.S. housing market between 1997 and 2012. The fundamental value of living in places such as San Francisco, New York and Boston and other superstar cities really did change. Tech boomed. Finance boomed. All kinds of other industries boomed. They drew in people from around the world who wanted good-paying jobs. Cities also got safer and prettier, with better green space and cool things to do, making living in urban cores more attractive. Meanwhile, there wasn't enough housing supply to accommodate this new demand.
"Those fundamentals made prices rise — but then homebuyers got over-optimistic about that," Chodorow-Reich says. And homebuyers getting over-optimistic became a serious problem because of the big role that mortgages play in financing homes. This debt was like strapping a stick of dynamite to price dynamics. When prices started to dip, a bunch of people started owing more on their mortgage than the value of their house. And, together with a broader recession that killed jobs and hurt incomes, that caused a foreclosure explosion.
A glut of foreclosed houses flooded the market, Chodorow-Reich says, and that pushed prices down so much they dipped below their fundamentals. But, they find, that also set up the conditions for the rebound. It explains why we began to see another housing boom after 2012 when the backlog of foreclosed houses had been bought up.
In media descriptions of the housing bubble, the poster children of the boom-bust cycle were places such as Las Vegas. And, in the economist's data, the prices of Las Vegas homes do show a massive bubble and crash. But while Vegas did see a fast rebound after 2012, the crash there was so large that its overall long-run growth is lower than in superstar cities, where booming innovative industries continued to bring in swarms of people wanting houses. So Vegas is a bit of an outlier and not as representative of the broader picture they paint of fundamentals-driven price growth.
What does this mean now?
The economists' data only goes through 2019, so they don't have much to say directly about the surging home prices of the pandemic era. However, Chodorow-Reich says, their paper can help us think about it. Demand for more space and hopes for continued remote work have made the suburbs more desirable. In other words, it's changed their fundamentals, especially considering the suburbs haven't been willing to build lots of new housing to accommodate new demand.
But there's also a lot of uncertainty about the future of remote work, and it's possible people are over-optimistic about these fundamentals. It's possible homebuyers are overestimating future demand to live in the burbs, or maybe people are overestimating the continued importance of superstar cities. To prevent a potential correction from exploding into something worse, Chodorow-Reich says, policymakers need to be mindful about the crucial role that over-indebtedness can have in turning a potential future dip into a full-on, cataclysmic crash.
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What Is a Housing Bubble?
A housing bubble, or real estate bubble, is a run-up in housing prices fueled by demand, speculation, and exuberant spending to the point of collapse. Housing bubbles usually start with an increase in demand, in the face of limited supply, which takes a relatively extended period to replenish and increase. Speculators pour money into the market, further driving up demand. At some point, demand decreases or stagnates at the same time supply increases, resulting in a sharp drop in prices—and the bubble bursts.
- A housing bubble a sustained but temporary condition of over-valued prices and rampant speculation in housing markets.
- The U.S. experienced a major housing bubble in the 2000s caused by inflows of money into housing markets, loose lending conditions, and government policy to promote home-ownership.
- A housing bubble, as with any other bubble, is a temporary event and has the potential to happen at any time market conditions allow it.
Watch Now: What Is a Housing Bubble?
Understanding a Housing Bubble
A housing bubble is a temporary event, but it can last for years. Usually, it’s driven by something outside the norm such as manipulated demand, speculation, unusually high levels of investment, excess liquidity, deregulated real estate financing market, or extreme forms of mortgage-based derivative products—all of which can cause home prices to become unsustainable. It leads to an increase in demand versus supply.
According to the International Monetary Fund (IMF), housing bubbles may be less frequent than equity bubbles, but they tend to last twice as long.
Housing bubbles don't only cause a major real estate crash, but also have a significant effect on people of all classes, neighborhoods, and the overall economy. They can force people to look for ways to pay off their mortgages through different programs or may have them dig into retirement accounts to afford to live in their homes. Housing bubbles have been one of the main reasons why people end up losing their savings.
What Causes a Housing Bubble?
Traditionally, housing markets are not as prone to bubbles as other financial markets due to the large transaction and carrying costs associated with owning a house. However, a rapid increase in the supply of credit leading to a combination of very low-interest rates and a loosening of credit underwriting standards can bring borrowers into the market and fuel demand. A rise in interest rates and a tightening of credit standards can lessen demand, causing the housing bubble to burst.
Mid-2000 U.S. Housing Bubble
The infamous U.S. housing bubble in the mid-2000s was partially the result of another bubble, this one in the technology sector. It was directly related to, and what some consider the cause of, the financial crisis of 2007-2008.
During the dotcom bubble of the late 1990s, many new technology companies had their common stock bid up to extremely high prices in a relatively short period of time. Even companies that were little more than startups and had yet to produce actual earnings were bid up to large market capitalizations by speculators attempting to earn a quick profit. By 2000, the Nasdaq peaked, and as the technology bubble burst, many of these formerly high-flying stocks came crashing down to drastically lower price levels.
As investors abandoned the stock market in the wake of the dotcom bubble bursting and subsequent stock market crash, they moved their money into real estate. At the same time, the U.S. Federal Reserve cut interest rates and held them down in order to combat the mild recession that followed the technology bust, as well as to assuage uncertainty following the World Trade Center attack of Sept. 11, 2001.
This flood of money and credit met with various government policies designed to encourage homeownership and a host of financial market innovations that increased the liquidity of real estate-related assets. Home prices rose, and more and more people got into the business of buying and selling houses.
Over the next six years, the mania over homeownership grew to alarming levels as interest rates plummeted, and strict lending requirements were all but abandoned. It is estimated that 20 percent of mortgages in 2005 and 2006 went to people who would not have been able to qualify under normal lending requirements. These people were dubbed subprime borrowers. Over 75 percent of these subprime loans were adjustable-rate mortgages with low initial rates and a scheduled reset after two to three years.
Much like with the tech bubble, the housing bubble was characterized by an initial increase in housing prices due to fundamentals, but as the bull market in housing continued, many investors began buying homes as speculative investments.
The government’s encouragement of broad homeownership induced banks to lower their rates and lending requirements, which spurred a home-buying frenzy that drove the median sales price of homes up by 55 percent from 2000 to 2007. The home-buying frenzy drew in speculators who began flipping houses for tens of thousands of dollars in profits in as little as two weeks.
During that same period, the stock market began to rebound, and by 2006 interest rates started to tick upward. Adjustable-rate mortgages began resetting at higher rates as signs that the economy was slowing emerged in 2007. With housing prices teetering at lofty levels, the risk premium was too high for investors, who then stopped buying houses. When it became evident to home buyers that home values could actually go down, housing prices began to plummet, triggering a massive sell-off in mortgage-backed securities. Housing prices would decline 19 percent from 2007 to 2009, and mass mortgage defaults would lead to millions of foreclosures over the next few years.
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