July 31, 2021

Will This Bubble Burst?

By Stephen Tuttle | July 10, 2021


There is a housing shortage, at all price points, locally and nationally. Materials needed to build housing are also in short supply, as are capable, skilled trades workers, a product of shutdowns during the height of the pandemic. With supply and demand in play, prices have been driven up at every level of the construction process.

There is, however, no shortage of home buyers so the demand stays high in the face of short and increasingly expensive supply. Prospective buyers, afraid they will be left with poor choices they can't afford, begin a version of panic home-buying. That further reduces supply, which further increases cost, which further increases demand, which further reduces supply … 

It certainly has a familiar feel to it. The housing market's bubble burst back in 2007, helping to fuel the Great Recession, still an unpleasant memory. We are being assured circumstances are far different now.

That housing bubble began expanding in the early 2000s as home prices rose precipitously. Mortgages were approved for nearly anyone, and subprime mortgages became their own form of investment vehicle. Bundled together, they paid big returns but carried significant risks as many of those home loans were backloaded; the monthly payments would explode with balloon payments in the coming years. 

Banks, insurance companies, and hedge funds invested huge amounts in all levels of the housing market. That helped prop up the bad loans until a prime rate increase by the feds stalled the housing market. When those balloon payments came due, many people could not afford them, some simply walked away, foreclosures exploded, home values plummeted, and an economic house of cards began a cascading collapse. Twenty-five major mortgage companies declared bankruptcy. The auto industry, investment houses, banks, and part of the insurance industry required government bailouts in successive administrations.

In the states that had the most dynamic population increases and housing demand — Arizona, Texas, Nevada, Florida — 25 to 40 percent of home buyers found themselves underwater: i.e., with plummeting home values, their mortgage obligation was far greater than the value of that home.

(It should be noted here that those people who weathered the economic storm and kept their home have done very well, indeed. For most, the current value of their home is considerably greater than it was at the peak of the previous price boom.)  

We can be reassured that very few of those circumstances currently exist. Mortgage rates are historically low, and lenders remain more careful than they were during the go-go early 2000s. Mortgages are still being bundled and offered as investments, but the low-interest rates eliminate the high-risk/high-reward paradigm that became so attractive two decades ago.

The pandemic has also helped drive demand, as many office workers have discovered they can work from home and no longer need to be in a dense, urban core near their workplace. They can now move to an area that provides them far more housing bang for their buck. 

Perhaps most importantly, there is less institutional investing and less home buying as a speculative investment. Most people now are purchasing a place they want to live in rather than an investment.

Which isn't to suggest there aren't some worrying signs — not the least of which is the dramatic increase in home prices. Even accepting that there is a supply-and-demand dynamic at play does not account for some of the skyrocketing home costs. It does cause concern that there is a certain buying frenzy of people hoping to avoid even higher prices in the future. We're reading stories about multiple potential buyers offering amounts, in cash, far greater than a home's asking price the same day the home is listed. Or auctions that can double the original asking price.   

The S&P CoreLogic Case Shiller U.S. National Home Price Indices (yes, it's really called that) says average home prices have increased more than 12 percent over the last year but nearly 3 percent in the last month alone, the fourth month in a row of accelerating increases.

The Zillow Home Value Index says average home prices in Traverse City, where the median price is now nearly $323,000, have increased some 16 percent in the last year. Other locations are almost out of control: Home prices in Austin, Texas, are up 42 percent over last year and now average more than $700,000. San Jose, California, has seen an even more daunting 45 percent increase, driving the average home price to $1.2 million. 

These increases are the largest since 2006 when that housing bubble was near bursting. But things are different now. Very few homeowners are underwater, equities are strong, the construction material supply line will become more robust, skilled workers will return to the job, housing inventories will increase, demand will ease, and balance will be restored.

At least, that's what we're being told. 


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