The following chart is of the most bubblicious Case-Shiller regions. Remember, today’s “September” Case Shiller is 8-month lagging (Case-Shiller is a 3 month average July thru Sept “closed” sales, which are a result of March through August shopping experiences and May through August Pending Sales…a long time ago) and house prices have stepped lower in the back-half.
1) It’s never different this time.
Both easy mortgage credit (Bush: Bubble 1.0) and the manufactured crushing of interest rates (Obama: Bubble 2.0) do the exact same thing to real estate (and other debt-backed assets). They promote house price inflation. In other words, they allow somebody to pay more for a house using the same amount of income.
Both the Bush and Obama administrations oversaw manufactured housing bubbles. And for numerous reasons I have argued for two-years I believe this bubble is far more dangerous that the last one.
Bottom line: House prices have retaken Bubble 1.0 levels on the exact same drivers: easy/cheap/deep credit & liquidity that found its way to real estate. The only difference between both era’s is which cohorts controlled the credit and liquidity. In Bubble 1.0, end-users were in control. In this bubble, “professional”/private investors and foreigners are. But, they both drove demand and prices in the exact same manner. That is, as incremental buyers with easy/cheap/deep credit & liquidity, able to hit whatever the ask price was, and consequently — due to the US comparable sales appraisal process — pushed all house prices to levels far beyond what typical end-user, shelter-buyers can afford. Thus, the persistent, anemic demand. And as these core housing markets hit a wall they will take the rest of the nation with them; bubbles and busts don’t happen in “isolation”.
2) Case-Shiller’s most Bubblicious Regions
- Ask Yourself: If 2005-07 was the peak of the largest housing bubble in history with “affordability” never better vis a’ vis exotic loans; easy availability of credit; unemployment in the 4%’s; the total workforce at record highs; and growing wages, then what do you call “now” with house prices at or above 2006 levels; high unaffordability; tighter credit; higher unemployment; a weak total workforce; and shrinking (at best) wages?
- Logical Answer: Whatever you call it, it’s a greater thing than the Bubble 1.0 peak.
The mind-numbing Case-Shiller regional charts below are presented without too much comment. The visual says it all…
3) BACK-HALF 2016 HOUSE PRICE HAIRCUT Bottom line: House-price haircuts are happening. House prices have softened considerably and are falling in several core markets, nationwide. Make no mistake about it. The data are clear. But, it simply takes time and sales to occur for the haircuts to turn into comps, the comps to impact other transactions, and for the recorded transactions to put the pressure on the popular house price indices.
House prices trend-changes and the reporting of such act like cancer; forms on day, grows, and spreads undetected until it presents in a way noticeable to the host, which at that stage can be advanced and untreatable.
4) A funny (and Demented) Seattle area Realtor anecdote regarding the potential for another housing Bubble: “House prices can’t be in a bubble because they are only 10% greater than the 2006 peak, meaning growth of only 1% per year since 2006. And 1% per year is not the Bubble type gains we saw back in the mid-2000’s”.
DOH! How do you argue with that? You don’t, you just turn the other cheek and pound a drink.
5) But, in my opinion, Bubble 2.0 is more dangerous than Bubble 1.0, in part, because…
- Bubble 1.0 had a much more stable, wider base of participants: tens of millions of individual “end-user, shelter-buyers or landlords” involved; much harder to deflate; price sensitive; variety of sell motivators required for a sustained down-cycle.
- Bubble 2.0 was driven by a relative handful of more “unorthodox” participants: insti’s, foreigners, high-tech workers, imported “skilled-workers”, private speculators, and price insensitive buyers in search of yield, laundering money, parking cash, and flipping (lack of end-user participation is obvious by persistently weak purchase apps, end-user resale purchases, and historically low builder sales relative to past cycles).
- Bubble 2.0’s high percentage of “all-cash” buyers removed the housing market’s “mortgage loan house price governor” allowing it to blow in the exact same manner exotic loans allowed Bubble 1.0 to blow.
- Bubble 2.0 saw much more inflation over shorter period (15% greater “appreciation” in 20% less time), which could set the stage for more deflation over a shorter period.
- Bubble 2.0 house prices in major metros are further detached from end-user, shelter-buyer employment and income fundamentals meaning further to fall before a wide demand base can be formed to stabilize the market.
- When Bubble 1.0 popped the Treasury and Fed had virtually unlimited balance sheet, bond yield, money printing, and loan manipulating (“modifying”) ammunition to “soften the landing”.
- Bubble 2.0 comes with the Treasury and Fed perilously light on ready-ammo to fight a larger pop. (Obama doubled debt to $20tt and Fed rammed its balance sheet to $4.5tt in order to halt the crash and produce fake 2% “growth”. There isn’t another $10tt to $20tt in Treasury and $4.5tt in Fed balance sheet room left for a do-over).
- The Bubble 1.0 pop had high-tech just beginning its long, debt-fueled, up-cycle providing a tailwind.
- Here, at the Bubble 2.0 peak, the tech/debt cycle is extremely mature — perhaps in an enormous bubble itself — and likely to be a drag on housing this time around. Especially, with Bay Area and other tech-centric, core housing markets across the nation so expensive based on most all known metrics.
- Trump’s cap gains plan would provide and escape hatch for unorthodox parties to liquidate a historical amount of Real Estate and to move capital into growth or higher yielding assets.
- Bubble 2.0 will end the same way as 1.0; a demand “mix-shift” and price “reset” back towards end-user fundamentals once the speculators finish up, or events force them to the “sidelines”.
- Lower prices will create demand, which the housing sector will always achieve one way or another…it’s what it does. Just like the anemic demand led the price crash of Bubble 1.0, which ultimately led to increased demand as prices stabilized lower.
- The Bubble 2.0 pop will also free up supply in the same manner as Bubble 1.0, just not as much from foreclosures. However, I do think people underestimate the volume of zero to low-down mortgages originated over the past several years, and those with little to no equity in legacy loans or rising interest rate mods, which if house prices drop a few percent turn high-risk, especially when factoring in the 6%+ cost to sell. But, it doesn’t matter where the supply comes from — maybe the PE firms start to dump rentals or immigrant Visa’s aren’t renewed — as it’s fungible.
- Sure the bubble could blow bigger. Maybe we get a double-bubble. Bubbles are strange things. But, when they begin to fall there is a lot of air under there because the downside has clearly been established.
- In 2008, Angelo Mozillo famously said “in my 50 years in this business I have never seen a soft landing”.
In closing, I live by the assumption that house prices will always gravitate to what the end-user, shelter buyer can afford using a tradition mortgage loan and minimal down payment. During certain times for various reasons prices can detach from end-user earnings and employment fundamentals. But, they always reattach over time. I believe the next several years is one of those times.