Is Housing a Bubble That's About to Crash?

We are all prone to believing the recent past is a reliable guide to the future. But in times of dynamic reversals, the past is an anchor thwarting our progress, not a forecast.

Are we heading into another real estate bubble / crash? Those who say “no” see the housing shortage as real, while those who say “yes” see the demand as a reflection of the Federal Reserve’s artificial goosing of the housing market via its unprecedented purchases of mortgage-backed securities and “easy money” financial conditions.

My colleague CH at recently posted charts calling this assumption into question. The first chart (below) shows the U.S. population growth rate plummeting as housing starts soar, and the second chart shows housing unit per capita, which has just reached the same extreme as the 2008 housing bubble.

Demographics and housing do not reflect a housing shortage nationally, though there could be scarcities locally, of course, and other factors such as thousands of units being held off the market as short-term rentals or investments by overseas buyers who have no interest in renting their investment dwellings.

On a per capita basis, housing has reached previous bubble levels. That suggests housing shortages are artificial or local, not structural.

Next, let’s consider how the current housing bubble differs from previous bubbles in the late 1970s and 2000s. In my view, the previous bubbles were driven by demographics, inflation and monetary policy: in the late 70s, the 65 million-strong Baby Boom generation began buying their first homes, pushing demand higher while inflation soared, making real-world assets such as housing more desirable.

Once the Federal Reserve pushed interest rates to 18%, mortgage rates rose in lockstep and housing crashed as few could afford sky-high housing prices at sky-high mortgage rates.

The housing bubble of 2007-08 was largely driven by declines in mortgage rates (as the Fed pursued an “easy money” policy to escape the negative effects of the Dot-Com stock market bubble crash) and a loosening of credit/mortgage standards. These fueled a bubble that morphed into a speculative free-for-all of no-down payment and no-document loans.

This decline in the cost of borrowing money (mortgage rates) enabled a sharp rise in the price of housing, a speculative boom that was greatly accelerated by “innovations” in the mortgage market such as zero down payments loans, interest-only loans, home equity loans, and no-document “liar loans”–mortgages underwritten without the usual documentation of income and net worth.

These forces generated a speculative frenzy of house-flipping, leveraging the equity in the family home to buy two or three homes under construction and selling them before they were even completed for fat profits, and so on.

Needless to say, the pool of potential buyers expanded tremendously when people earning $25,000 a year could buy $500,000 houses on speculation.

Once the bubble popped, the pool of buyers shrank along with the home equity.

If we study this chart below of new home prices (courtesy of Mac10), we can see that the 21st century’s Bubble #2 rose as the Federal Reserve pushed mortgage rates far below historic norms. Once rates reached a bottom, the 7-year inflation of home prices (from 2011 to 2018) began rolling over.

This deflation of home prices was reversed by the pandemic recession, as the Fed’s vast expansion of credit and mortgage-buying, which pushed mortgage rates to new lows. Trillions of dollars in new credit and cash stimulus ignited a speculative frenzy in stocks, bonds and real estate, a frenzy which drove bubble #3 to extraordinary heights.

All this unprecedented fiscal and monetary stimulus also ignited inflation, and so rates are rising in response. Bubble #3 is already deflating, at least by the measure of new home prices.

But the current bubble has a number of dynamics that weren’t big factors in previous bubbles.

One is the rise of remote work. Many people have been working remotely since the late 1990s enabled Internet-based work, but the pandemic greatly increased the pool of employers willing to accept remote work as a permanent feature of employment.

This trend has been well documented, but the consequences are still unfolding: remote workers are no longer trapped in unaffordable, congested cities and suburbs.

Several other trends have attracted much less attention, but I see them as equally consequential.

1. Housing in many urban zones are out of reach of all but the top 10% without extraordinary sacrifice, and now that employment isn’t necessarily tied to urban zones, the bottom 90% of young people without family wealth or high incomes are coming to realize the benefits of urban living are not worth the extreme sacrifices needed to buy an overvalued house.

A middle-class life–home ownership, financial security, leisure and surplus income to invest in one’s family and well-being–is no longer affordable for the majority of young Americans.

Few are willing to concede this because it reveals the neofeudal nature of American life. Those who bought homes in coastal urban zones 20+ years ago are wealthy due to soaring housing valuations while young people can’t even afford the rent, much less buying a house.

If you’re not making $250,000 or more a year as a couple, the only hope for a middle-class life that includes leisure and some surplus income to invest is top move to some place with much lower housing and other costs. That place is rural America.

2. The benefits of urban living are deteriorating while the sacrifices and downsides are increasing. Urban living is fun if you’re wealthy, not so fun if you don’t have plenty of surplus income to spend.

Urban problems such as homelessness, traffic congestion and crime are endemic and unresolvable, though few are willing to state the obvious. Americans are expected to be optimistic and to count on some new whiz-bang technology to solve all problems.

Unfortunately, problems generated by dysfunctional, overly complex institutions, corruption and unaffordable costs can’t be solved by some new technology, and so the decay of cities will only gather momentum.

The hope that billions of federal stimulus funding would solve these problems is about to encounter reality as the funds dry up and all the problems remain or have actually expanded despite massive “investments” in solutions.

Few analysts have looked at the finances of high-cost cities. The decline in bricks-and-mortar retail, rising crime, soaring junk fees, rents and property taxes have all made urban small business insanely costly and therefore risky.

Small businesses are the core sources of employment and taxes. As high costs, crime, etc. choke small businesses, employment and tax revenues drop and commercial real estate sits empty, generating decay and defaults.

Once office and retail space is no longer affordable or necessary, commercial real estate crashes in value as owners who bought at the top default and go bankrupt.

People need shelter but they don’t need office space or to start a bricks-and-mortar retail business.

As urban finances unravel, cities won’t have the funding to run their bloated, inefficient, overly complex and unaccountable bureaucracies.

3. In geopolitics, we speak of the core and the periphery. Empires have a core (Rome and central Italy in the Roman Empire) and a periphery (Britain, North Africa, Egypt, the Levant).

As finances and trade decay and costs soar, the periphery is surrendered to maintain the core.

In urban zones, the same dynamic will become increasingly visible: the peripheral neighborhoods will be underfunded to continue protecting the wealthy enclaves.

Crime will skyrocket in the periphery even as residents of the wealthy enclaves see little decay in their neighborhoods.

This asymmetry–already extreme–will drive social unrest and disorder. This is a self-reinforcing feedback: as the periphery neighborhoods deteriorate, the remaining businesses flee and the smart money sells and moves away.

Tax revenues plummet and city services decay even further, persuading hangers-on to move before it gets even worse. Cities compensate for the lower revenues by increasing taxes on the remaining residents and cutting services.

Each turn of the screw triggers more closures and selling and fewer tax revenues.

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