Bubble Watch investigates trends that may indicate economic and / or real estate problems ahead. This time, a more philosophical analysis.
Bad news: California house prices look bubbly.
Good news: values don’t have to painfully fail to correct overpricing.
Californians were left with understandable scars after the Great Recession destroyed psyches, careers, checkbooks and equity. But that does not mean that every time home buyers go a little crazy – a well-documented California habit – there should be sharp and rapid price drops.
The surprisingly high house prices last year in an economy torn apart by the pandemic were unnerving. It was a wave driven mainly by historically low mortgage rates that helped balloon house hunters seek larger spaces due to the coronavirus’s renewed lifestyles.
“Bubble” means that the price of an asset has exceeded its underlying value. No one has explained to me clearly how homes will remain unscathed after the virus is brought down and the bargain financing disappears – even if the Federal Reserve gives a lot of warnings because it is promising.
Note that just a 1 percentage point jump in mortgage rates from today’s historic lows below 3% would reduce a typical home hunter’s purchasing power by about 12%.
Then, I realized that a history class was in order. I filled out my reliable spreadsheet with 1975 California home price statistics, using a slow index from the Federal Housing Finance Agency. What I discovered were three distinct “corrections” – defined by me as long periods between the records of this index.
Yes, “it’s different this time” may be true. Each of these painful periods has its own storyline – from the backstory to the duration, to the end.
1980: quick fix
A battle against inflation created a short and moderate price correction over two years.
California home prices had risen at a rate of 16% a year for seven years, to record levels in the fall of 1981. These were turbulent times. The global instability and scarcity of oil created by an Arab embargo on US imports helped raise inflation to 9% that year – making housing gains, let alone wages, worth much less.
So the Federal Reserve took severe measures to moderate inflation, intentionally freezing the economy. Yes, it seems that central banks tend to play a role in the housing market. Interest rates soared and mortgages reached unfathomable levels above 18%.
But prices during this correction fell just 11% to the bottom of the cycle – and would hit a new high in the fall of 1983 … as rates dropped to, sip, 13%!
1990: Long malaise
The poor economy translated into a housing malaise that lasted for much of the decade.
When the Fed stopped tying the economy of the 1980s, California’s businesses and housing boomed – although mortgages have never been well below 9%. The savings and home-loan industry actively borrowed in a last bailout. Prices appreciated at an annual rate of 10% for 7 years, reaching a record high in the summer of 1990.
Then, California struggled to rock a small national recession. S&L left and the end of the Cold War decimated the state’s aerospace industries. Mortgage rates fell below 7%.
But the housing fix in the 1990s is often overlooked due to its unusual pain.
A slow and winding economy meant that California’s next real estate record would not be seen until the fall of 1998 – yes, more than eight years between peaks. But, during this prolonged slowness, the price index fell only 13% to its bottom.
2000: big explosion
A painful fall after a great deal of real estate insanity meant 12 years between peaks.
You could expect the weakness of the 1990s to turn into a significant recovery. There was a pent-up demand for housing. In addition, California’s business climate was overheated by the emerging dot-com economy. Prices rose at a rate of 14% per year for eight years.
The real estate momentum seemed unstoppable as prices minimized the temporary collapse of the tech industries, the 9/11 terrorist attacks and a mild national recession. How? Aggressive lenders and willing borrowers were doing really stupid things – like buying houses that few could afford.
The correction of these horrible business practices, poor regulation and individual errors has burst the bubble in the global Great Recession. The California real estate market fell in a fall that cut 41% from the top price index in the summer of 2006.
It would take 12 long years – and mortgage rates below 5% – to erase those losses and reach a new peak in the summer of 2018. And since then, the housing market has generated eight more price hikes as the Fed has further increased. housing rates%.
Result
The story goes that the Great Recession cash pain was horrible – and most likely, not much like the pandemic era. However, this does not mean that the overheated property markets of 2021 will not face any noteworthy challenges.
Perhaps the conditions for buying a home today are more similar to those of the early 1980s, when the Fed was trying to solve a broader economic challenge and the business climate responded favorably. The correction of house prices at that time was quick and modest.
And don’t ignore the 1990s as a possible guide to a pandemic. The decade’s prolonged economic weakness created a long-standing fear for California’s housing markets.
What is equivalent to eight years of zero valuation of the house price is a “fall” or a “correction”?