The symmetry of housing price history is disturbing to some investors and economists. In 2006 home prices reached their apex and began to decline. Five years later, the decline reached its nadir and prices began to recover. Next year, five years into the housing price growth, housing prices will probably have returned to their 2006 level.
What bothers some analysts is the five-year down phase approximately matched by the five-year up phase. The question they are asking themselves is whether this is some sort of market cycle that will soon bring another housing bust?
There is general agreement that the housing price situation was a bubble. And when that housing bubble burst, it took Wall Street and the rest of us with it.
Which is it, then? Is it a bubble now? Is the five-year pattern a fearful symmetry or just a coincidence? And, if it is a bubble, is it likely to burst when the five-year cycle ends in 2016? Or is the housing picture fundamentally different now from the pre-crash period?
There certainly is an eerie resemblance between where we are now and those pre-crash days that, as the song goes, “we thought would never end.” A report published by the New York Federal Reserve Bank in 2004 was entitled, “Are Home Prices The Next Bubble?” and addressed the concerns of investors and economists at that time.
What their research indicated was that, “A close analysis of the U. S. housing market in recent years, however, finds little basis for such concerns. The marked upturn in home prices is mostly attributable to market fundamentals. Home prices have essentially moved in line with increases in family income and declines in nominal mortgage interest rates.”
What the writers of that time didn’t know was that the great brains in our financial world hadn’t yet thrown their full weight into prolonging the housing boom. This was done through a simple move: expand the demand side by lowering the qualification standards for borrowers. The home mortgage market in the last few years before the bubble burst were dominated by unqualified buyers and what became known as “low-doc” and “no-doc” mortgages.
Underwritten by collateralized mortgage obligations of dubious real value and even more dubious risk disclosure to investors, the housing boom was prolonged by lending to people whose only hope of making payments on their mortgages was by refinancing their homes — a process that required uninterrupted escalation in home prices. It also meant that the borrowers would keep paying loan fees, increasing their debt, and retaining near-zero equity.
That is the missing element in today’s housing market. By and large, mortgage lending standards have not been eroded by lenders’ greed or led astray by government leadership, at least not yet. How they might react to the first hint of a downturn in home prices, of course, is another matter.
Researchers at the Federal Reserve Bank of San Francisco analyzed the current housing market and found that both the loan and the household financial data are encouraging. In a report entitled, “What’s Different About The Latest Housing Boom,” they write that, “…conditions in the latest boom appear far less precarious than those in the previous episode. The current run-up exhibits a less-pronounced increase in the house price-to-rent ratio and an outright decline in the household mortgage debt-to-income ratio, a pattern that is not suggestive of a credit-fueled bubble.” If the current housing market is a bubble, it is a bubble that is different from the one that burst in 2007-2008.
The Federal Reserve is responsible for monetary policy to promote full employment and low inflation, and is naturally worried about asset bubbles. Its efforts to find a bubble definition sturdy enough to support monetary policy, though, have produced disappointing results. It is still not clear how to distinguish a bubble from a rising price environment caused by shifts in supply, demand, or both. And, worse, it is not clear what kind of Federal Reserve intervention would deflate a bubble efficiently enough to avoid widespread collateral damage throughout the economy.
In the end, it may be about symmetry after all. The current housing market is different from the bubble of last decade, but home prices still might stall or even decline. And because the Federal Reserve cannot really lower interest rates that are already near zero, our economy will have to respond on its own as best it can. That would be different from last time, too. What haven’t changed are the imbalances in the overall economy, and in the housing market, due to wage stagnation and artificially low interest rates. Those factors provide enough symmetry with the pre-crash markets to make the prospect of a faltering housing market worrisome.
James McCusker is a Bothell economist, educator and consultant. He also writes a column for the monthly Herald Business Journal.