Home prices have surged during the pandemic, leaving many to believe we’re either in a housing bubble or heading toward one.
The good news, however, is that the United States is not about to repeat the 2005-07 housing boom and bust, which led to the Great Recession. Basic supply and demand factors — not speculation, predatory lending and/or bad underwriting — are driving home prices. Moreover, a series of mortgage-market safeguards should prevent a hard landing when home prices recede.
Existing home prices were up 23.4% in June over the last year, according to the National Association of Realtors. This price spike reflects a pandemic-induced confluence of events, and demographic factors, which drove demand for homes, following more than 15 years of housing underinvestment.
Demand for homes spiked during the pandemic as the Federal Reserve slashed interest rates to zero, driving mortgage rates down to record lows. Freddie Mac’s 30-year fixed mortgage rate hit an all-time low of 2.65% in January and remains historically low, at around 2.8%.
Adding to demand was the wave of Americans who were suddenly working from home during the pandemic. Many sought larger spaces with home offices and other amenities, dramatically raising demand for new and existing homes. This also occurred as the oldest Millennials reached the age (30 to 40) when homebuying becomes attractive and many are starting families and saving.
This combination of factors drove household formations (e.g., moving to a new home or apartment away from parents or roommates) to a rolling 12-month total of 4.95 million by mid-2020 compared to roughly 1.5 million households formed on a 12-month rolling basis the year before — an all-time high we estimate using Census Bureau data.
Available housing, meanwhile, has been woefully insufficient for the rising demand.
It’s a shortfall that has been a long time coming. The decade after the 2005-07 housing boom and bust saw chronic housing underinvestment, leading to anemic growth in stockpiles. The brief pop in housing material costs (lumber and copper, for example) this year has also dampened attempts to increase inventory, inflating home prices.
In 2019, there was an average of 889,000 single-family home groundbreakings per month, according to the Census Bureau. In 2021, that figure was 1,130,000 per month on average. It’s a welcome increase given the low inventory, but the 2021 levels pale in comparison to the pre-bubble peak of 1,823,000, in January 2006. The number of existing homes for resale in June — 1.25 million — was roughly one-third of the 2007 peak of 4.04 million.
It’s no surprise that sky-high demand and scarce supply have sent home prices aloft. Indeed, according to Redfin, residences that remained on the market for about 44 days pre-pandemic were being snapped up in as little as 15 days as of July of this year.
Still, it is unlikely that an eventual slowdown in home prices would trigger another Great Recession-type event because financially fit homebuyers and mortgage-market guardrails should help prevent one.
Most new mortgages are fixed-rate, as opposed to the riskier adjustable rate mortgages that were more prevalent during the mid-2000s boom and bust. Moreover, most new homebuyers have higher credit scores and more income compared to the housing bubble’s sub-prime borrowers.
These factors suggest less risks to homeowners, and the housing market in general, should the Fed raise interest rates. Both individuals and the market are better positioned to weather bumps in the road.
Moreover, depository institutions (i.e., banks and credit unions) and government-sponsored enterprises, or GSEs, like Fannie Mae and Freddie Mac, hold most mortgage debt. This shift occurred as a consequence of the Dodd-Frank Act of 2010. Banks and credit unions are heavily regulated and must have robust capital structures to mitigate risks. These factors suggest limited financial market risk should prices dive, as these institutions are unlikely to buckle under financial stress.
A large remainder of mortgages are held by mortgage Real Estate Investment Trusts (REITs). While regulated by the Securities and Exchange Commission, REITs are not backstopped by the entity. However, the Fed can step in and deploy quantitative easing to help alleviate pressures in the REITs market with purchases of mortgage-backed securities to provide liquidity.
So, we should not fear that this red-hot housing market will collapse and cause great economic pain. This time, the market is built on a firmer foundation than the fragile bubble that grew and burst in the mid-2000s.
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