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Housing Bubble Over? Hardly

Anthony Randazzo
February 9, 2012, 2:20pm

The raging debate over whether we've reached the bottom of the housing market is like a broken record. For the last several years we have pointed out repeatedly that the annual claims of a housing bottom are off base and should be ignored. (As a side note, I've never understood the value of being in the camp that correctly calls a housing bubble, the odds are that you are wrong and if you are right you won't get much credit for the call, still the bulls persist.)

Anyway, Bill McBride has noted for the past couple years that we should think of the housing bottom in two ways: the bottom for housing starts and sales, and the bottom for prices.

Usually when talking about the bottom of housing the topic is prices. That is what homeowners and homebuyers care most about. That is what impacts the level of household debt and negative equity in the system. It is an important bottom to consider. 

McBride made the argument last week, though, that the bottom for new starts is here and while I think that is overly bold, the data do show the rate of decline in starts and new home sales to be slowing down. At the very least, 2012 will not be the worst year in recent member on housing starts. But an important thing to consider is that Fed monetary policy (both through the Fed funds rate and QE) is keeping mortgage rates low, but this will not last forever. Even if we have ZIRP until 2016, rates will eventually "normalize" meaning mortgage rate sof 6 percent to 8 percent again soon, and that will mute new home demand. Today's artificially low rates are just moving homebuyers from the future into the present, meaning we'll see this all balance out over time (like Cash for Clunkers, see Figure 1 from this 2010 article).

When it comes to housing prices though, I would expect we'll see prices fade past the "fair value" level that we are nearly back to on a national level, before hitting bottom. I also don't think it is possible to reach a natural bottom with all of the government subsidy money for housing finance still in the system. Even if we bottom out by the end of 2012, since housing finance reform won't be completed by then, it will be a false bottom and the renewal of another bubble. 

Another reason to expect that housing prices are not at their bottom, natural or otherwise, is that families don't buy homes without jobs, income, and savings. Unemployment numbers may look positive in the headline, but down deep still have significant problems—especially the fact that labor force participation has declined meaning there are more families just sitting around without jobs even though they are not technically counted as unemployed. Incomes have remained stagnant too and savings are weak. And what savings there has been has been muted by the Fed's monetary policy of zero interest rates. 

So, yes, price-to-rent ratios are inflation adjusted prices are "normal looking" as McBride wrote last week. No doubt, and it is a positive thing to see real housing prices approaching the historical trend. But that does not preclude a boomerang in prices that would mean another year of falling values. It also does not take into account the subsidies in the system that remain. And it does not consider the fact that interest rates will not stay low forever.


Anthony Randazzo is Director of Economic Research


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