Is Housing In a Bubble?
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Are we dancing with the 2008 housing bubble devil once again? Or have the fundamentals changed?
There is certainly a hot real estate market reminiscent of 2008.
*Number of home sales increased 8.6% year over year.
* Median sales price increased 10% compared to prior year.
*36% of all home sales went under contract within the first week on market.
*Most recent November Case-Shiller index saw a record breaking 9.5% increase in home prices.
First, let's understand what causes a bubble:
Easy money/credit flowing into an asset class causes bubbles. This "cheap money" is the main ingredient. This "easy money" invites speculation and over time people lose site of fundamentals. It's that simple.
Example: Imagine how a consumer will behave with a 0% interest credit card vs. a consumer with a 18% interest rate credit. The consumer paying 0% is much more likely to take unreasonable risk than the consumer with a real interest rate.
These low interest rates change behavior slowly. It is a slow process similar to floating away from the shoreline. Over time, the market drifts away and completely loses site of normalcy. Everything around them begins to look the same- nobody realizes how lost they've become. Then if one see's others in the same position, people begin to trust their untenable situation.
The easy money of 2000-2003
The Federal Reserve Bank controls the interest rate that banks will lend to consumers. The recession that began in 2000 led to interest rate cuts led by Fed Chairman Alan Greenspan. His cut's were called the "Greenspan Put". At the time he was dubbed a "maestro" for his ability to almost wave a magical wand over the markets. When in reality- Greenspan was juicing the economy with cheap money creating asset bubbles.
As you can see from the overly simplistic timeline above-- we experienced an unprecedented (for the time) low interest rate environment from Jan. 2001-June 2004. This low interest rate environment over time peeled away any sensible risk-reward approach.
This removal of a sensible risk-reward combined with an easy entry to the real estate market manifested itself in a real estate bubble. This real estate bubble would have been confined to only the United States if it weren't for the derivative markets. These derivative markets infiltrated the international financial system. Essentially, the world financial system began gambling on the surety of the real estate market in the US. These bets were such a "sure thing" that institutions began levering up balance sheets to buy instruments with a higher interest rate than the cost of borrowing the original money. The spread was retained as profit along with fees for these transactions.
It's simple to understand that a normalized interest rate would have curtailed these bubbles from appearing.
The worrisome part is that this is the damage that was caused by only two and a half years of low interest rates. This begs the question-- what bubbles could have formed during 11 years of interest rates between 0.00-2.25%...? Or have the fundamentals changed enough to negate this concern?
IS THERE A CASE FOR STRONG FUNDEMENTALS DRIVING THE HOUSING MARKET?
Yes, there is a case to suggest this is a fundamentals driven housing boom. First, like all commodities, there is a supply and demand relationship for housing prices. Currently we have record low inventory. The low rate interest rate environment is fueling a buying spree that is sucking up the few homes on the market, driving prices higher.
The sentiment is that we have to wait for new home builds to catch up in order to offset this supply and demand ratio.
However, we have one problem, lumber prices have tripled since the beginning of the year.
The 300% increase in lumber prices is accomplishing one of two things. First, the building of new homes will slow due to the higher cost of construction. Secondly, when these homes are built the price tag is going to have to reflect the high cost to build these new homes. Ultimately, these two fundamentals will continue to drive home prices higher.
FED CHAIRMAN POWELL HAS ALREADY FORECASTED NO RATE HIKES
Fed Chairman Jerome Powell has already forecasted that he won't attempt to raise rates until 2022 at the earliest. This forecasts means there is at least another year of rising home prices. Yes home prices are expensive, but prepare for them to get a lot more expensive. If this is a housing bubble, we certainly aren't going to pop it in 2021.
The new Biden administration will certainly look to combat rising home prices by easing the barrier of entry into the housing market. The end result will inevitably be an increase on the demand side, driving prices even higher.
$3 TRILLION MORE IN CASH CIRCULATION
Since the Covid-19 pandemic has started we have not only seen lower interest rates, but we have seen the Federal Reserve flood the markets with an extra $3T in cash via quantitative easing (QE). This cash has to find a home somewhere. Similar to post 2008 it seems to find itself in the housing markets.
Former Fed Chairman, Ben Bernanke, launched the famous QE monetary tool in order to boost asset prices after the 2008 financial crisis in order to create a "wealth effect". Between 2008 and 2020 the federal reserve pumped approximately $3T into the US economy. The effects were seen in rising stock market and housing prices during the last decade. Since the Covid-19 pandemic the Federal Reserve has dumped another $3T into circulation since between March 2020 and Feb. 2021. This QE tool is the main difference between the market of 2000-2008 and the housing market between 2008 and present. This shifts the risk from an asset bubble problem to a US dollar purchasing power problem.
I believe Americans can't afford to not buy a house today. Yes, home prices are high but I believe prices will continue to become more unaffordable over the next decade. The bubble that lead to the financial crisis in 2008 was fueled by low interest rates. Our QE monetary response to that crisis has forever changed our fundamentals. In my opinion income and wealth inequality was caused by the Federal Reserve's cash injections into our economy in order to boost asset prices. Asset owners flourished and non-asset owners fell behind.
Since the Covid-19 crisis, the Federal Reserve has accelerated the QE process that caused wealth inequality in the first place. It is a real possibility that the best thing an American ought to do is overpay for a house today, because they will have to overpay a lot more in the future. It will be vital for Americans to lock down their largest expense in today's purchasing power rather than the cost of living in tomorrow's.
John Lawrence is an investment advisor and founder/owner of J.A. Lawrence Wealth Management, LLC.
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