US housing bubble starts to deflate as sellers cut prices and mortgage rates rise

The BabyBoomers made US housing more expensive from the 1970s, as the largest generation in history settled down and bought houses. And then the Fed launched its subprime and stimulus bubbles, which led prices to double between 2003 – 2021. 

The chart highlights the result, based on median new US home prices and household incomes:

  • Home prices in 1967 were less than 1x incomes before the Boomers began their buying spree
  • By the time they had finished in 2000, the ratio had more than doubled to 2.5x
  • Then Alan Greenspan and Ben Bernanke began their subprime and stimulus bubbles
  • By the time they had finished, the ratio had more than doubled again to reach 5.8x today

Their tactic was simple. Crash interest rates to near zero and flood the market with liquidity.

The effect was the same as in the stock markets, as I described last week. House prices rose to new highs as the cost of borrowing collapsed:

  • When the Boomers bought, their monthly payment had to cover interest and capital repayment
  • But for the past 20 years, buyers have believed that home prices would never fall
  • So expensive homes seemed more affordable, as buyers only worried about paying the interest bill
  • And as interest rates went lower, they decided they could afford to buy a more expensive home

But now interest rates are rising fast as the second chart confirms. Mortgage payments are up almost 50% since the start of the year.

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Inevitably, therefore, the bubble is starting to burst as the Financial Times charts confirm:

  • Homebuilders haven’t noticed yet, and so they are building record numbers of new homes
  • But mortgage applications have fallen off a cliff

Many people have simply decided to stay where they are, given today’s eye-popping prices. As the Financial Times notes, the issue is affordability:

“Suppose back in December you were going to buy a house for $425,000 with 20% down. But you didn’t get a deal done for whatever reason. The change in rates means that the monthly mortgage payment on your dream home has now gone up about 30%, from $1,442 to $1,877. That’s $5,220 in additional payments a year.

“More to the point, if your mortgage budget was fixed at about $1,442, you are now shopping for a $325,000 house. That is a really different house. And so, unsurprisingly, many buyers are saying the hell with it. Applications for purchase mortgages (that is, not refinancings) are down by a third from their coronavirus pandemic peak.”

WHAT HAPPENS NEXT – WATCH OUT FOR DEBT, DIVORCE AND DEATH?

Most economists and commentators have only been in the market for the past 20 years. So they assume that prices will always go up. Any downturn is just temporary as the Fed will quickly launch more stimulus.

But those, like us, who remember the pre-Greenspan era know that prices can – and do – go down. And as Redfin reported last week:

“Housing Market Update: Nearly 1 in 5 Sellers are Dropping Their Price”

Most homeowners suffer from loss-aversion. They see that prices are falling, but they refuse to follow the market lower. Instead, the selling is led by people who have to sell due to the “3 Ds”  – Debt, Divorce and Death.

The Fed might change its mind and rush to support asset markets again. But that seems unlikely today. If it doesn’t, then debt, divorce and death will force an increasing number of people to sell their home. And if buyers continue to disappear, then sellers will have to continue cutting prices in order to try and achieve a sale, as the bubble finally bursts.