I am in the process of building a house, so I recently met with the manager of a real estate agency to discuss the sale of my current house in about a year. Knowing that I worked in finance, he asked for my views on the housing market as he said he saw a lot of unhappiness on the internet.
It’s a housing crisis, not a crisis
First, all real estate is local. The housing market where I live in coastal South Carolina is still strong. Although transactions are down from a year ago, it is because there are very few homes on the market. Lots of people – many of whom have money and aren’t affected by rising interest rates – are coming from other parts of the country, and I’d have no problem selling my house today if I wanted to. . He accepted.
He also agreed when I told him that you can’t randomly scroll through Twitter these days without falling into predictions of an impending housing bust. Jeff Weniger, head of equities at WisdomTree Investments, recently posted a Twitter thread titled “Housing is in trouble” that has gone a bit viral. The thread was well-researched with charts and data to back up each of its points, such as how the supply of new homes has exploded, as have monthly mortgage principal and interest payments. As a result, the National Association of Home Builders’ Housing Market Index fell. Sales of new and existing homes fell sharply and affordability fell to 2005 levels.
Some people take these facts and extrapolate them into a thesis that a housing crisis is coming that will be equal to or greater than the one we had in 2008. In fact, judging from what I read online, that seems to be the prevailing opinion. I guess some of that is understandable. The Federal Reserve is raising interest rates like never before, and I suspect that in a nightmare scenario, higher borrowing costs will stifle credit demand. But I doubt it will go that far, given the importance of the housing market to the economy, accounting for between 15% and 20% of gross domestic product.
There are two main reasons why we are not going to see another housing crisis. The first is that housing is financed very differently from the years before the collapse of subprime mortgages and the resulting financial crisis. You had no money on mortgages, “liar” loans, NINJA loans, interest only mortgages, negative amortization mortgages and many financial innovations on top of these – which have all facilitated by poor underwriting standards. Then, these mortgages were bundled into bonds with the best AAA credit ratings. These bonds were then grouped into higher risk securities called secured debt securities which were also assigned the highest credit ratings. Finally, Wall Street has created many hundreds and hundreds of billions of dollars worth of risky credit default swaps tied to all of these bonds and CDOs. It was a virtual daisy chain of leverage, and when people stopped paying mortgages they shouldn’t have had first place, there was a domino effect that led to the bailout of some of the biggest major financial institutions in the country.
Today, there is no market to speak of for subprime mortgages or related bonds, CDOs and credit default swaps. What exists is negligible and certainly not a threat to the financial system. I’m not a huge fan of regulation, but clearly things like the Volcker Rule, the Dodd-Frank Act, and Basel III have made the financial system safer by limiting excessive risk taking. In fact, it can be nearly impossible to have a housing crisis again. I recently got a construction loan for my new home and I can assure you the underwriting standards were the opposite of lax. At the very end of the process, my lender demanded a 30% deposit instead of 20% to be on the safe side.
The second reason is that consumers have massively deleveraged. Nearly half of mortgaged properties were considered equity-rich in the second quarter, meaning owners had at least 50% equity, according to real estate data provider Attom. Bloomberg News reported that this was the ninth consecutive quarterly increase, helped in part by an increase in deposits from recent buyers. Nationally, the share of equity-rich mortgage homes hit a record 48.1% last quarter, up from 34.4% a year earlier. Meanwhile, the share of homes considered seriously underwater – where the mortgage is 25% higher than the property’s estimated market value – has fallen to a low of 2.9%.
Something else to consider: the debt service ratio of US households has fallen from around 13% during the last housing crisis to less than 10% today, according to the Fed. The amount that households spend to service their mortgage debt has been reduced by nearly half, from 7.18% in 2007 to 3.89% recently. It wasn’t house prices that killed us in 2008, it was leverage. Sure, it’s possible to have a bear market without leverage, but you’re not going to have a generational bear market without leverage.
The other thing people forget is that real estate is a very good place to invest in inflationary environments. It is a traditional store of value. And there are certain demographic factors that could push housing higher – much higher. Only 48.6% of Millennials own a home, which is 20% less than Gen X. Like baby boomers, Millennials represent a huge demographic bulge and they’re not done buying. Sometimes I wonder if housing will do over the next decade what Canadian housing has done over the last, and that is continue to grow despite the odds.
Let’s not get caught up in a whirlwind of real estate misfortune. I promise it will be fine. I predict we will have a small price correction of around 10% with limited fallout, and then the housing market will resume its upward march.
More other writers at Bloomberg Opinion:
• Don’t sweat a housing crash as long as wages go up: Conor Sen
• Resist the siren song of 40-year mortgages: Alexis Leondis
• Will housing prices simply flatten or collapse? :Jonathan Levin
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Jared Dillian is the editor and publisher of Daily Dirtnap. Investment strategist at Mauldin Economics, he is the author of “All the Evil of This World”. He may have an interest in the areas he writes about.
More stories like this are available at bloomberg.com/opinion