The prevailing belief that helped to spark the last housing crisis was that homes are an investment. That price will keep going higher. We’re now 8 years out of the peak of the last housing bubble. But have we formed a brand new one with reckless monetary policy?
US home prices rose 35% in the last four years
The S&P Case Shiller housing index (above) shows an ominous chart of home values. The first take away is that even 8 years after the previous housing crisis, prices have not returned to their previous highs, despite a large increase. And this is with the backdrop of the most accommodative monetary policy in US history — with specific support for mortgage backed securities to help lower interest rates on borrowing.
Adjusted for inflation that gain is muted
Prices, when adjusted for purchasing power, are not responding to stimulus as policy makers may have hoped. This means that while housing prices have gained in notional value, the purchasing power of the dollar has weakened during that period enough to offset much of that gain. So much for being a promising investment.
Cheap debt is the key to this bubble
The largest support mechanism in place for the current housing market’s uptrend has been very, very low interest rates. Some would say this presents a fantastic opportunity to buy a home with a lower monthly mortgage rate. But what’s not factored in to that logic is everyone else has the same idea — and thus there is an extremely high amount of artificial demand pushing prices up from borrowers who otherwise could not afford to take out a mortgage on a property that is overpriced.
The normalization of interest rates would turn this support mechanism on its head and begin to drain excess demand from the housing market. Whether that happens because the Federal Reserve begins a tightening cycle or because mortgage backed security holders become nervous and begin to sell their assets remains to be seen.
Knowing that the primary support mechanism for the current housing price boom is entirely artificial, and has been for the better part of the last decade, is an important foot note at the very least. It may even prove to be the signal that tells us when this latest housing bubble may pop.
Once more, the housing market is entirely dependent on the stability of and confidence in global financial markets. Any market meltdown will have a profound effect on the housing market. And every financial market is interconnected to such an extent that a problem in Shanghai can become a problem on Wall Street very quickly.
Prices are artificially high because of monetary stimulus, not a booming economy. Affordability is near all-time lows for similar reasons.
These gross distortions have created an unsustainable paradox: Houses priced beyond the reach of most Americans — while wages stagnate, labor force participation is at multi-decade lows and the next generation of consumers has an enormous student debt load preventing them from buying a home.
If you are selling a home, this is probably the best time in recent history to exit the real estate market to reduce risk.
If you are buying a home, be extremely careful. And be prepared to lose a good chunk of that home’s value (or wait until prices normalize and buy in at what will likely be a much lower price).