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Was there even a housing bubble?
15 years of hindsight
Ask someone what caused the Great Recession, and the typical answer you’ll get is something related to the housing bubble. People know the basics of the story. In the mid-2000s, bankers started issuing riskier and riskier mortgages to homebuyers. Gone were the days when a prospective homebuyer needed to have good credit, stable income, and put 20 percent down on a house to get a mortgage. Banks slowly, then quickly, relaxed these requirements. By 2006 people were buying homes using so-called NINJA loans, which meant a buyer had no income, no job, or assets. People were buying homes that there was no way they could afford. Stories of minimum wage workers buying properties worth hundreds of thousands of dollars were common. Real estate prices shot up.
Why would banks do this? Two reasons. First, as long as the property market continually gains value, there isn’t a bad outcome for the bank. If the homeowner pays off their mortgage every month then the bank makes their standard profit off of the interest. If a homeowner falls behind on payments or stops making them entirely, the bank can repossess the house and sell it for a profit. It’s a win-win for the bank. The second reason banks were issuing such reckless loans was that they weren’t holding onto the mortgages. Local banks around the country would take their new mortgages the week they were signed and sell them to a bigger bank that would package thousands of loans together into a mortgage bond. These mortgage bonds were then sold to various investment groups. This was seen as a safe investment because 1) even if some of the mortgages go bad profit can still be made on all the ones that don’t and 2) because real estate prices never fall there’s no way to lose money.
Of course, it isn’t the case that real estate prices never fall. The housing market went so ballistic in the mid-2000s that there was no way it could last. People were buying and reselling homes and realizing double-digit profit margins every year. Individuals were locking into mortgages with low initial “teaser rates” that would later increase and double their required monthly payment. People didn’t understand how these adjustable-rate mortgages worked and were falling behind. Default rates on adjustable-rate mortgages went from around five percent to eight percent in a few years. Now it wasn’t the occasional loan going bad, it was a common thing.
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The result was the Great Recession. The biggest economic collapse in the United States in a century. Because mortgage bonds were being bought and sold by intermediaries across the financial world, investment banks that had never issued a single mortgage were on the hook for billions of dollars. Other banks had offered insurance policies on mortgage bonds, and now that those bonds were collapsing had to pay up. Unemployment neared 10 percent. It took years for the economy to recover.
That’s the narrative that most would have agreed with in 2015. Now, however, that narrative needs to be looked at closely. Because while housing prices did drop significantly between their July 2006 high and February 2012 low, since the housing market has only increased. Take a look at the Case-Shiller home price index:
The market decrease during the Great Recession is clear. Prices went down significantly. But a bubble? It looks like people may not have been wrong to value property this highly, they were just a bit early. Of course, being wrong and being early is often the same thing in the financial world. Still, it’s looking increasingly difficult to call the housing market surge in the mid-2000s a bubble.
Economic bubbles are when the price of a commodity, security, or other asset increases dramatically in price and then sees an equally dramatic price decrease that is long-lasting. The Japanese stock market, which I cover here, is a great example of a bubble. The Japanese stock market went stratospheric in the 1980s, peaking in December 1989. Then it crashed, and here’s the key part, has still not recovered. The stock market is still underwater 34 years later!
The American housing market is far different. First, the housing market increase wasn’t as frothy nationwide as people like to remember. Some markets, especially in Florida and California, did have ludicrous increases. Nationwide, however, housing prices increased by 50 percent in the five years to the July 2006 peak. That’s a big change, but an asset increasing by 50 percent over five years isn’t going to break any records. It happens all the time. Second, the fall wasn’t that large either. With the same caveats that some markets saw far worse, the nationwide average was a 30 percent drop. Again, significant, but not earth-shattering. In fact, the housing market had a lower value in 2003 than it did during the nadir of the trough in 2012. The longest the housing market on the whole was underwater was roughly 11 years. Again, I’m not trying to diminish the financial loss and pain that some individuals went through during this time. I’m just saying that if the housing market doesn’t look like much of a bubble at the national level. Pity those that bought a house in 2005-2007. Most everyone else bought homes that gained value within a decade.
Since then, the housing market has done fantastic, even to the detriment of the American economy, as I wrote about here and here. People who bought homes at any time before 2021 have seen their home valuations go to the moon. Between 2012 and 2022 the average property owner saw their home’s value more than double. Even those that bought at the peak in 2006, if they held on, have seen their properties increase by almost 70 percent. This is all persuasive evidence that there was no bubble to begin with.
The best counter-argument against all this is that there was a housing bubble, but the US government stepped in and prevented it from popping completely. When it was suddenly possible that the entire financial system might collapse in the summer 2008, the Fed stepped in. To the tune of more than a trillion dollars, the government pumped money into the economy and successfully staved off a complete implosion. So it would be reasonable to argue that without that stimulus, housing prices would have sunk far lower than they did and may still be under their 2006 peak. That said, the government stepping in to prevent a total collapse of the economy and preventing a bubble still means there wasn’t a bubble.
The next natural question, of course, is whether we are in another bubble right now. Housing prices have increased faster in the last five years than during the supposed bubble of 2001-2006. Will history repeat itself? Time will tell.