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Housing: Don't Compare the Current Housing Boom to the Bubble and Bust
Look instead at the 1978 to 1982 period for lessons
It is natural to compare the current housing boom to the mid-00s housing bubble. The bubble and subsequent bust are part of our collective memories. And graphs of nominal house prices and price-to-rent ratios look eerily similar to the housing bubble.
However, there are significant differences. First, lending has been reasonably solid during the current boom, whereas in the mid-00s, underwriting standards were almost non-existent (“fog a mirror, get a loan”). And demographics are much more favorable today than in the mid-00s.
Compare to the 1978 to 1982 period instead
A much more similar period to today is the late ‘70s and early ‘80s. House prices were increasing sharply. Demographics were very favorable for homebuying as the baby boomers moved into the first-time homebuying age group (similar to the millennials now). And inflation picked up from an already elevated level due to the second oil embargo in 1979, followed by the Iran-Iraq war in 1980, driving up costs.
In 1979, the Volcker Fed responded by raising rates, and combined with inflation, this pushed up mortgage rates sharply. Now the Powell Fed is embarking on a tightening cycle and mortgage rates have already increased significantly.
For review, here is a graph of expenditures on energy goods and services as a percent of total personal consumption expenditures through February 2022. The huge spikes in energy prices during the oil crisis of 1973 and 1979 are obvious (the black arrow points to the 1979 increase in prices). Oil prices have increased sharply recently, but energy consumption is a smaller percentage of the overall economy now.
The second graph shows the year-over-year change in inflation since 1959. The black arrow points to the pickup in 1979. Note that inflation was already elevated prior to the oil shock. This time inflation picked up due to the impact of the pandemic, and more recently due to the Russian invasion of Ukraine.
And here is a graph of mortgage rates from Freddie Mac. Freddie reported 30-year rates were at 4.67% in the last sample period.
Mortgage rates are still historically low; however, I think it is the change in mortgage rates that impacts the housing market. The next graph shows the year-over-year change in mortgage rates.
The recent year-over-year change in mortgage rates is about the same as during the late ‘70s period - even though overall mortgage rates are much lower than in the late ‘70s / early ‘80s.
What Happened to Housing in the 1979 to 1982 period?
Here is a graph of real house prices using the Case-Shiller National house price index. Real house prices peaked in 1979, and then declined about 11% over the next 3 years. Note that in nominal terms, house prices increased slightly during that period, but the high inflation rate eroded the real value.
House prices tend to be sticky downwards in nominal terms. During the housing bust, it was the flood of distressed sales that led to cascading price declines, but that didn’t happen in the 1979 to 1982 period.
The real price decline following 1979 was small compared to the 36% decline in real prices following the housing bubble.
And here is a graph of new home sales. The black arrow points to 1979. New Home sales declined in half from about 800 thousand per year to about 400 thousand per year.
And months-of-supply increased sharply, but this was mostly due to the decrease in sales, as opposed to an increase in inventory.
And single-family housing starts collapsed in 1979.
What does this suggest for housing now?
Some of the factors are different today. Inflation was much more embedded in 1979 than today, and the oil shock exacerbated that situation. That meant heavy lifting for the Volcker Fed. And I believe for-sale inventory today - especially for existing homes - is much lower than in 1979 (unfortunately I do not have the existing home inventory data for that period).
However, we should expect something similar to the what happened in the late ‘70s - a decline in real house prices seems likely, and I also expect some decline in housing starts and new home sales. With solid lending, nominal prices should be sticky downwards, and I don’t expect national declines in nominal prices.
The size of the declines in new home sales and housing starts will depend on how much inflation is embedded, and therefore how much the Fed will have to raise rates (and reduce their balance sheet) to control inflation. If a large portion of inflation is transitory, the impact on housing will be minimal. However, if the Fed has to raise rates significantly, then we would expect a larger impact.
Currently we just have to watch and wait. However, we can be fairly confident that we won’t see cascading nominal price declines like during the housing bust - since there will be few distressed sales.
I will write much more on why we should be looking to the late ‘70s period for lessons, as opposed to the housing bubble.