What is more amazing?
-That the Fed can keep creating more bubbles while barely getting over the last one?
-Or that people keep falling for the same tricks?
We are in the second major housing bubble this century, and we aren’t even a quarter of the way through this century.
The last housing bubble started in the early 2000s, or some might argue the late 1990s. It peaked around 2006 or 2007. The slow decline turned into a much faster decline when the financial crisis hit in 2008. The housing market bottomed out around 2011.
If you bought a house in the United States in the 2010 to 2012 timeframe, you probably got a really good deal, at least compared to today’s standards. It was also a time of relatively low interest rates, so you could get a low-interest mortgage with your low-priced house.
Now here we are. It’s about 16 years since the peak of the last housing bubble. It is only about a dozen years since the bottom of the last housing bust. Yet, here we are again.
From One Bubble to Another
It surprised me that there was a stock market bubble in the mid 2000s. The Nasdaq tech bubble should have been fresh in everyone’s memory except the very young. It’s almost as if it hadn’t happened.
The tech bubble happened in the 1990s and peaked in early 2000. Then stocks tumbled for the next two and a half years. While all of the major stock indexes fell, the Nasdaq was the hardest hit, falling nearly 80%. That really is a situation where the term “crash” is appropriate.
With the recession in 2001, coupled with the 9/11 attacks, the Greenspan Fed went to work creating new money and lowering interest rates. The stock market went from bearish to bullish quickly. It took only a few years to be back in bubble territory and then the financial crisis in 2008 sent stocks down again. It didn’t take that long.
Compared to the stock market bubbles, maybe the real estate bubble makes a little more sense. It is obviously driven heavily by interest rates, and it has taken longer to build up. It also makes some rational sense to buy property in an environment of persistent inflation.
Whether you define inflation as an increase in the money supply or an increase in prices, it still makes sense to not hold dollars that are becoming less valuable over time. If you lock in a fixed-rate mortgage, that payment will become smaller in real inflation-adjusted terms over time. In 30 years, your last mortgage payment might be the equivalent of a nice dinner.
The Perfect Interest Rate Storm
The Fed has been faced with inflation over the last couple of years (that it created), and it has been aggressively hiking its overnight lending rate (the federal funds rate). This has resulted in short-term interest rates going a lot higher. Long-term rates have gone higher too, but just not as much. This is why we still have an inverted yield curve.
The yield curve has started to flatten, which, if anything, just means that a recession is closer. But the yield curve is flattening because longer-term rates are going higher. The 10-year yield, which is highly correlated with mortgage rates, is nearing 5%.
A typical 30-year mortgage now has a rate around 7.5 to 8%. A 15-year fixed rate mortgage is around 7%.
In early 2021, you could get a 30-year fixed rate mortgage for around 3%.
This is a dramatic difference, especially with housing prices at high levels. It is one thing to have a 4% or 5% difference when taking out a $100,000 loan. It is quite another when it is a loan for a half million dollars, which is a typical middle-class house in many areas today.
A loan amount of $500,000 for 30 years at 3% will result in a monthly payment (principal and interest) of $2,108.
That same loan at a rate of 8% will result in a monthly payment of $3,669.
If rates ever hit 10% for mortgages, that will be double the monthly payment as compared to 3%.
In other words, if someone buys the same $500,000 house with zero money down today, they would be paying about $1,400 to $1,500 more per month than if they had bought about 3 years ago.
Yet, in most cases, that same house is actually more expensive today than it was 3 years ago without even considering mortgage rates.
The Bust Will Come
You would have to be desperate to buy in this market, but there are some people who really are desperate. There might be a very tiny fraction who can buy a house without a mortgage, but we know that is rare in today’s world.
Some new buyers are probably hoping that rates will go back down so that they can refinance within the next few years. But so far, that hasn’t happened. Rates keep going higher.
People who own a property with a low fixed-rate loan do not want to sell because they have such a low rate. This keeps inventory off the market, which is probably the main reason that prices have not come down much.
But it gets to a point where housing is unaffordable for the average middle class American. We are at that point now. The median income can’t buy the median house, especially at today’s rates.
Something will have to give. It will either be prices or rates, or possibly both.
Rates could conceivably come down significantly with the onset of a recession. But if a hard recession is the reason for rates going down, it probably means that asset prices will be falling hard too.
Unless the Fed goes back to a policy of very easy money, we are going to see a housing bust.
We’ll see what happens after that. Maybe the Fed will lower rates and create more money out of thin air to save us from their last bubble and bust. And then we can start the process all over again.
When will the Fed learn? The answer is: probably never. The interests of the central bankers are not the same as the average American. That’s why people need to learn not to get wrapped up in the Fed’s bubbles.