Bubble will burst?
For starters, all bubbles pose this issue – there is never a consensus that the bubble – however big it may be – is indeed a bubble. By definition, that always has to be the case as otherwise we will not have one in the first place. But as I see it, I look forward to writing the concluding part of my trilogy on “Why 2023 has to be worse than 2008” sometime during the next few weeks i.e. post the crash of housing bubble 2.0. Part I & Part II of that series can be read here[1][2].
Why housing prices are a bubble
1. US Housing Affordability Index
Both the figures represent the same data i.e. US Housing Affordability Index – over varying timeframes. The Affordability Index is a comprehensive indicator that accounts for housing prices, individual incomes, and interest rates. This index has fallen by nearly 50% in the last 18+ months i.e. since the start of the rate hiking cycle by the US Fed.
Interestingly, the affordability Index today at 87 is not substantially higher than what it averaged during the early eighties when the 10-year treasury rates were quoting at 15%+. The 10-year treasury today is just about 4.3% – a fraction of what it was during the eighties. If the 10-year were to just reverse the inversion of the yield curve and catch up with the Fed funds rate, affordability will decline even further.
More importantly, as I have written earlier, the trend of rising interest rates is here to stay for years and years to come. At some point in the next few years, affordability will easily retest the lows of the early eighties.
2. Events leading to a bubble burst
a. Low Unemployment
Both the bubbles in the current century (2000 – Nasdaq bubble and 2008 – US housing Bubble/ GFC) have been accompanied by cyclically low unemployment numbers.
The unemployment rate of just around 4.0% seems to be the point at which the bubbles break. At this point in time, we have been below 4% for nearly 2 years.
b. Trend of increasing US Fed funds rates leading to a bubble burst
Both the bubbles bursting mentioned above were accompanied by the US Fed raising the effective Fed funds rate over a period of time.
Nasdaq – The Fed raised its effective rate from 4.63% during Jan 1999 to 6.54% by July 2000. The Nasdaq bubble burst in March 2000 – about 15 months since the rate hike cycle was initiated by the US Fed.
Housing Bubble 2008 – The rate hike cycle started during Jun 2004 from 1% to 5.25% during Aug 2006 – over a 26-month period. The bubble burst during Sep 2008 with the collapse of the Lehman Brothers and over the next few months, the housing bubble morphed into what is now known as the GFC i.e. Global Financial Crisis.
2023 – The rate hike cycle was initiated during Feb 2022 when the Fed effective rate was raised from 0.08% to 5.33% by Aug 2023. When the house bubble 2.0 bursts in the next few weeks/ months, this will morph into something much bigger than a housing bubble crash. Not even a GFC 2.0, but probably a GCC (Global Currency Crisis).
I can point to a number of other indicators – the ratio of median incomes to median housing prices, the absolute increase in housing prices over trend, etc., to show why the 2023 bubble is much bigger than the 2008 one. These and more have been explained in the previous two articles linked above.
Readers can legitimately raise an interesting question at this juncture about 2019. This period also was preceded by cyclically low unemployment as well as a rate hike cycle i.e. from Nov 2015 when the rate was 0.12% to 2.4% by Jan 2019. We were indeed ripe for the bursting of the housing bubble 2.0 even back then, but the then Covid induced regulatory changes (moratorium on foreclosures, etc.), and an extraordinary stimulus prevented the burst. That monetary stimulus which continues to this day is the bandage that is holding a broken US Economy together.
The fiscal deficit for 2020 was $3.13 trillion and for 2021 it was $2.77 trillion. Even if one were to justify the same as a necessity of the Covid era, what was the economic rationale for the $1.38 trillion stimulus during 2022 (in comparison, the post-2008 crash peak stimulus was $1.42 trillion during 2009)?
If the preemptive stimulus of $1.38 trillion during 2022 was irrational, the projected stimulus for 2023 at nearly $2 trillion is nothing short of stimulus on steroids. At a time when unemployment is at a near-all-time low and GDP growth is supposedly at a healthy 2%+, what was the need for this massive deficit spending? Ignore Keynes; even Marx wouldn’t have justified this.
To summarize, it is this extraordinary preemptive stimulus that has prevented the housing bubble from bursting in the last few years. But all bubbles eventually find a pin. The only question is how much longer can the US Govt/ Fed postpone the day of reckoning for the US housing market?
We will return to the above question in a while. Before addressing that, it might be worthwhile to debunk some of the “facts” propounded by the “No housing bubble” enthusiasts. They primarily refer to two data points – low inventory and a relatively modest decline in housing prices despite a steep increase in borrowing rates – to claim that there is no bubble.
The “Low Inventory” Myth
As can be seen from the graph below, the Total housing units has been on a near linear trend line from 2000 to this day – with modest ebbs and flows around 2008. Readers should also remember that the US housing market went from a housing shortage in 2007 to a massive surplus in 2008. How does one even reconcile with this sudden flip of market conditions when the underlying fundamentals was every bit predictable?
What happened in that intervening period was the change in perception about housing being a perpetual piggy bank to a subprime asset. That alone led to a massive surplus in the inventory.
If we look at the trendline of Total housing units or even a comparison with the population, these have been remarkably steady over the last 2+ decades. There was a brief slowdown post the 2008 crash, as can be expected, but the pace recovered by 2012 and the gap between the populations to housing units today is almost the same as was the case during 2008.
But the really telling statistics that we are sitting on a tsunami of shadow inventory comes from the per-capita housing numbers. Using a very simple Total housing Units to the total population ratio, we are currently at almost the same level as we had during 2008. A more accurate way to measure this would be the per capita ratio for the working-age population as they are the most probable buyers of the housing units. This ratio has practically skyrocketed over the last 5+ years and well beyond the 2008 numbers as can be viewed from the graph below.
The above is the analysis of the completed housing units. How about the housing construction pipeline? To add insult to injury, the picture only gets worse.
As can be expected of a bubble, the number of units under construction is substantially higher than what happened even during the peak of the 2008 bubble (graph on the left side). The graph on the right indicates the marginal addition to population per new housing start and this ratio is now less than 1. If this does not indicate a bubble, then we should wonder what else can possibly can.
In summary, the shortage of housing inventory is a complete myth caused by speculators hoarding housing units in anticipation of house prices recovering. Not only is the existing stock of units comparable to the 2008 levels, but the under-construction inventory that is about to flood the market is even higher. When seen in the context of the declining working-age population and rising rates, the picture gets worse. Add in the forecasted GCC, and the housing industry to going to be delivered a mortal blow from which it’s going to take a decade or longer to recover.
The Myth of Relatively Stable Housing Prices
The other data point that is used to refute the housing bubble 2.0 hypothesis is that despite a steep increase in interest rates, the fall in housing prices has only been marginal. This argument ignores several key factors as explained below:
- The decline in median pricing from $480,000 to $416,000 over a 6-month time period is not marginal to any extent. We have witnessed a 13% fall and are well past the halfway stage of price declines that would qualify housing to be in bear market territory.
- The price correction has just started. As compared to 2008 when a lot of the investors were on arms (adjustable rate mortgages) that pulled the legs of the housing market from down under, more than 99% of the buyers today are on fixed-rate mortgages. So the manifestation of increased interest rates is going to be felt first in the new housing sales rather than the current mortgage holders. MBS will witness a trickle-down impact. Interest rates are high enough as it stands and time alone is sufficient to be the straw that will break this camel’s back.
- Usage of Median numbers could be misleading under certain conditions. When a certain segment of the housing sales is more adversely affected more than the others, then the median number comparisons could be misleading in assessing the overall state of the industry. For example, if the low end of the market has completely vanished, the effect will be an increase in the median prices up though unit prices in every category could have declined. For this reason, median prices understate the extent of the increase in boom times as well as the declines in bust periods.
So there we have the two main claims – low inventory and relatively stable prices – exposed for what they really are. Having settled the claims, we can now return to the question of the timing of the housing bubble 2.0 crash that lies ahead.
The Housing Bubble 2.0 Burst
Forecasting the timelines for bubbles bursting is fraught with risks. With that risk well acknowledged, I would look at this bubble persisting beyond 2023 as a very unlikely scenario. There are a number of pins floating around – both internal and external – to the US economy that could be the proximate reason.
But as I see it, a reader needs to understand none of the above – inventory, low unemployment, prices falling, etc. – all these are secondary factors. The elephant in the room as far as the housing bubble 2.0 is concerned is the affordability crisis of the US consumer and the trends of increasing interest rates due to the inflation pipeline that has been built prior to 2022 with nearly 15 years of ZIRP. That this bubble will burst in the near future is a certainty in my opinion.
Whether the bursting of HB2.0 leads to GCC is an unanswered question.
Note:
1. Text in Blue points to additional data on the topic.
2. The views expressed here are those of the author and do not necessarily represent or reflect the views of PGurus.
Reference:
[1] Why 2023 has to be worse than 2008 – Jan 05, 2023, PGurus.com
[2] Why 2023 has to be worse than 2008 – Part 2 – Mar 21, 2023, PGurus.com
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2. Returned to India in 2005 and have been an investor ever since
3. Focus on investing in precious metal equities, particularly Gold, Battery Metals and Uranium Juniors.
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