Why is everyone so worried about another housing bubble?
With house prices high relative to income, many fear lenders inflated a new housing bubble to bail them out from the old one.
Home shoppers recoil at today’s home prices. Years ago people reveled in high home prices, often buying for fear of being priced out or for greed to capture home-price appreciation; however, high home prices no longer excite buying frenzies since the housing bust. Plus, lenders won’t enable buyer foolishness any more.
So now when home prices go up, people worry about whether or not prices will crash again — and with good reason. If mortgage interest rates rise significantly, lenders don’t have affordability products to cushion the payment shock, so sales will crumble, and if rates remain high for long enough, house prices may fall.
But how realistic is it that mortgage rates will go up and stay up? I recently speculated that We’ve reached a permanently low floor in mortgage interest rates. I believe mortgage interest rates can’t go up unless we have a huge increase in demand for housing, which doesn’t seem likely any time soon. If rates were to move up like they did in mid 2013, then demand will crumble (like it did in 2014), and rates will need to fall in order to reignite demand (like it did in 2015).
If mortgage rates were to rise, it would cause a dramatic decline in home sales because cloud inventory restrictions prevents owners from lowering their prices. This would cause so many problems with housing that the federal reserve would need to increase it’s bond purchase program (printing money) to lower rates to keep the housing market functioning.
If the federal reserve failed to act, and if mortgage rates were allowed to drift up to 5% or 6% or higher, we would endure a complete collapse in sales volumes and massive unemployment among homebuilders, realtors, and mortgage loan officers, causing house prices to fall again, exposing banks to tremendous losses. Given those problems almost certain to accompany higher rates, it simply won’t be allowed to happen — even if that means the federal reserve buys every mortgage in America.
Price-to-rent or payment-to-rent?
How can we say that prices are high today? What benchmark of value can we rely on? Many people who are concerned about a housing bubble point to the inflated price-to-rent ratio, which suggests housing is 30% overvalued.
As with any aggregate measure, the price-to-rent ratio has its weaknesses. Since price-to-rent doesn’t factor in the influence of financing terms, it does not capture the effect of record low mortgage rates. So while this indicator says prices are too high, it fails to acknowledge that those high prices are easily financeable.
My favorite measure of value for individual properties and the entire market is the ratio of rent to home ownership cost. I prefer this method because it incorporates the effect of mortgage rates and more closely emulates the conditions people face when they decide whether to rent or own. By the payment-to-rent ratio, houses are as affordable today as any time in the last 28 years.
Home shoppers today are right to be concerned about another housing bubble. The tools on this site are designed to help spot this bubble if it forms and direct people to the properties with the best payment-to-rent ratio available in the market.
Relative to rent, house prices are similar to the stable period from 1993 to 1999. And the new mortgage regulations will prevent future housing bubbles because the “Ability to Repay” rules will prevent reckless lending.
Says it won’t cause the next financial crisis.
Warren Buffett says now is a good time to buy a house, though not as good as it was four years ago. Still, Buffett says he thinks the chances of housing prices collapsing are very low.
“I don’t see a nationwide bubble in real estate right now at all,” says Buffett. …
“In Omaha and other parts of the country people are not paying bubble prices for real estate,” says Buffett. …
In Berkshire’s 2012 annual letter, Buffett recommending housing as an undervalued asset. Buffett said housing is not as good a deal as it was in 2012, but he didn’t think housing looked overpriced now either. Prices nationwide have rebounded a lot and now stand near where they did in 2007. Some analysts have warned that housing prices are set to plunge.
Warren Buffet believes in his own analysis. His manufactured home company, Clayton Homes, just bought two production homebuilders. My guess is he anticipates a large uptick in new home demand as the Millennials form new households.
Of course, Warren Buffet could be wrong.
Back when the 2005-07 housing bubble was brewing, photos of impossibly small houses selling for insanely high prices famously made the rounds. It was one of those signals that you look back on and say, “Hmmm … that was a clear indicator of trouble ahead.”
Do you remember Dr. Housing Bubble’s Real Homes of Genius?
So in what feels like déjà vu, it’s worrying now to see a glorified “tool shed” on the market in New York for a cool $500,000. In Brooklyn, no less. Not even in Manhattan. …
Here are some other troubling anecdotal signals on the housing market:
1. A major financial website recently ran a guide to the best cities to “flip” houses in. (I don’t want to encourage the behavior.) Real estate speculation via house “flipping” was another early sign of trouble ahead.
Not necessarily. When ordinary citizens with no background, experience, or training start to flip homes, then trouble is brewing.
2. A few days later, news arrived that home prices in the Bronx had shot up by an astonishing 30% in the first quarter. Crazy advances in home values were, a decade ago, also a signal of trouble ahead.
House prices shot up significantly from 2012 through mid 2013, but this was not a bubble. Why? Because the rapid appreciation was from an undervalued condition. If such a rally started at fair value — like today’s prices — then it’s time to sound the alarm.
3. Ads, then as now, were running on TV for “quick mortgages.”
All of these signals raise a serious question: Are we getting closer to another housing meltdown that will once again damage your investment portfolio?
To find out, I recently checked in with Stephen Oliner of the American Enterprise Institute and the Ziman Center for Real Estate at UCLA, who tirelessly tracks the housing market for signs of trouble.
His take was not exactly encouraging. We’re actually a lot closer to potential housing-market problems than you might think. The reason? Easy credit is back.
Really? I don’t know what data he is looking at, but FICO scores are up significantly since the housing bust.
Credit is not overly tight, but it certainly isn’t overly loose either.
The notion that you need to save a lot of money to buy a house is again being treated as so much “baloney,” said Oliner.
I’ll show you why, in a sec. But first, thankfully, at least a full-blown repeat of the 2008 financial crisis is unlikely. That’s because banks aren’t amplifying the problem via wholesale repackaging of home loans into risky investment instruments. At least not yet. …
Packaging good loans into mortgage-backed securities is the backbone of our housing finance system. Every loan insured by Fannie, Freddie, or FHA is packaged and sold to investors. Securitization was not the cause of the housing bubble: it was the loans they securitized. As long as investors have no appetite for Option ARMs, everything will be fine.
Let’s take a look at the signs of trouble brewing in housing, yet again.
We’re just about back to the zero-percent down payment
“No money down” was one of the big problems contributing to the housing bubble 10 years ago. Unlike the 20% down payment of yore, the availability of zero-money-down loans encourages people to buy homes beyond their means. It also means from Day 1, buyers are underwater, taking closing costs into account.
Zero-money-down creates incentive to buy as much home as possible. That’s true; however, bankers must underwrite loans in accordance with the the “Ability to Repay” rules, which means the borrowers can all afford their payments. So while the borrowers may want to buy more house than they can afford, bankers won’t let them — which is how the system should work.
All of this will compound problems if the economy turns downward and people lose jobs, since they’ll have no cushion in the form of home equity. When you’re underwater in your home, that makes it easier to walk away. Conversely, if it forces you to stick it out, you’ll be less likely to sell (for a loss) and move to where your next job might be.
We know from observation during the bust that those who could afford their homes did not strategically default in large numbers.
So it’s disconcerting to see that first-time home buyers now put just 3.5% down on their homes, or $8,500, according to Oliner’s numbers.
Why? It’s only disconcerting if they strategically default, which most won’t.
Buyers are stretching their budgets to purchase homes
A lot of people are taking out mortgages with dangerously high monthly payments relative to their incomes. And the problem is getting worse.
Here’s how we know: Government regulators say the debt-to-income ratio (DTI) for home buyers can go up to 43% before they risk running into trouble. The DTI measures all monthly loan payments — for things like credit cards, cars and mortgages — against monthly income. Three years ago, 22% of home buyers were above this limit. In March, that number was up to 28%.
The FHA and GSEs can exceed these limits, but their exemptions from Dodd-Frank requirements expire next year.
For context, back in the early 1990s, when the fear of housing-market blowups wasn’t yet a “thing” thanks to more conservative lending standards, only about 5% to 10% of loans were at or above the 43% cutoff.
For context, back in the early 00s, lenders completely lost their minds and put no limits at all on back-end DTIs.
“Many of the mortgages being taken out now don’t make sense in terms of the likelihood of people being able to repay the loans,” observed Oliner.
If this were true, the flood of “Ability to Repay” lawsuits will be crushing to whatever lender and investor holds this garbage. Since lenders and investors know they face this risk, it’s very unlikely today’s mortgages are that bad.
We see the same thing with credit scores. In March, first-time home buyers had a median FICO score of 706, compared with an overall median of 713.
As I pointed out above, FICO scores are up significantly from the bubble era.
The upshot: We’re a lot closer to 2007 than you might think
No. We’re not.
I could go on refuting each of the points raised in the post, but I’ve already destroyed the foundation, so the rest crumbles of it’s own weight.
It’s all about mortgage rates
If mortgage rates remain low, housing will do well, and we are in little or no danger of a price decline.
If mortgage rates rise slowly, either the market will absorb the higher costs, or the friction will slow sales and drag on house prices.
If mortgage rates rise quickly, the drag on sales and prices will be extreme, and either rates will come back down, or things will get ugly. But what does “ugly” really mean? If prices are too high for borrowers to finance, and if this causes or coincides with an economic recession prompting waves of defaults, it still won’t necessarily cause a price crash.
Lenders learned from the housing bust that they will get bailed out by government cash and federal reserve interest-rate policy, and they can avoid mortgage default losses by loan modification can-kicking until prices rebound. As long as they don’t foreclose and resell for a loss, they can amend-extend-pretend their way out of any disaster.
If rising mortgage rates causes instability in the market, lenders will use their “new and improved” loss mitigation procedures, and sales volumes fall to lows never before measured, even lower than the worst sales years of the most recent housing bust. Prices probably won’t go down much, but the entire housing market will seize up as buyers can’t afford prices sellers must obtain. That’s what I mean by “ugly.”