More than half of homes in the US are selling above list price. People are playing a lottery to see if they’ll win the honor of spending hundreds of thousands of dollars to build a home. The Case-Shiller US National Home Price Index looks like a rocket ship launching into space. You’d be forgiven for flashing back to the aughts but listen closer, that’s not Fearless playing, it’s Fearless (Taylor’s version).
There’s a growing sense of unease. Renters at the lower end of the market have seen their rents rise in some places even as they’re more likely to be suffering the economic harms of the last year. Would-be homeowners are furious as they lose bidding war after bidding war, looking for someone to blame as they watch their peers land a home and lock in a low mortgage rate. And homeowners are riding high for now, exhaling sighs of relief that they made it into the exclusive club and eagerly watching their wealth skyrocket, worried about what might happen to change that.
The last crisis, when a housing bubble and risky behavior by Wall Street took the blame for the Great Recession, looms large in our collective memories. And with America’s unemployment numbers still not where we want them and the unequal economic recovery from the pandemic, the fear of another crash looms. It’s unsurprising, then, that the questions “are we in a housing bubble?” and “will the housing market crash?” saw a “tremendous increase” over the last 12 months, according to Google Search.
Prices rise and fall for assets all the time for a variety of reasons, so what makes something a bubble? Yes, housing is a scary place to see volatility (it’s the largest asset most of us will ever have), so part of this fascination with housing bubbles is people paying more attention than they might with other assets. For example, used car prices have skyrocketed nearly 50 percent over the last year, but very few people are asking if there’s a used car bubble.
The reason for this likely is that the most recent time the housing market attracted such universal attention, lots of people decided it was a bubble. But there’s no agreed-upon economic definition for an asset bubble. And in everyday conversation, it appears to mean “prices have gone up a lot and I think they’re going to come crashing down again.”
In a way, it doesn’t really matter what we call it. There are fundamental problems in the housing market that have to be fixed and the solutions for them are relatively straightforward. Whether prices will come down, stop appreciating, or this is a new normal in the price of homes depends on public policy choices that are in our control.
What even is a housing bubble?
Ask two Nobel Prize-winning economists, and the answer is blunt:“It’s impossible to know for sure whether something’s a bubble,” said Richard Thaler in a conversation with his colleague Eugene Fama.
“What’s the bubble?” Fama added. “The up? The down? The subsequent up?”
And yet, there are instances that feel like “bubbles” — Thaler cites the 2000s housing market — prompting quite a bit of effort between the two economists to define it.
Harvard economist Robin Greenwood and his fellow researchers looked at 40 times when stock prices have increased over 100 percent and found that a “sharp price increase ... does not, on average, predict unusually low returns going forward.” That is, a quick price boom does not mean an inevitable crash (though they do find evidence for the “increased probability of a crash”). This means just because prices rise really fast doesn’t mean it’s a bubble in danger of popping. The definition needs to be narrower than that.
But bubbles are more than just a sharp increase in prices — there’s also an accompanying frenzied ethos that’s integral to the definition. The Harvard researchers called it investors rushing “toward a new Eldorado.”
“I would say it’s defined in terms of ‘people parameters,’” Robert Shiller, another Nobel Prize-winning economist, explained in an interview. “A bubble is a time when price increases in some markets attract a lot of attention ... I have been thinking about epidemiology, and blooms in speculative bubbles are a sort of epidemic of an idea, of a feeling of what one should do with one’s life or leisure or what’s cool.”
In general, what people are looking for to determine if there might be a bubble in housing is that the fast price appreciation is detached in at least some ways from the fundamental reasons why prices increase or decrease normally (like supply or demand).
Kevin Erdmann, a somewhat heterodox researcher in this space based at the Mercatus Center, is very skeptical of bubbles: “An argument could be made that housing has never really left the fundamentals,” he explained. Instead of a so-called “bubble,” he argues that we had a “housing supply bust” that caused prices to appreciate quickly in places like New York City, Los Angeles, Boston, and San Francisco. This in turn created a migratory phenomenon where households flooded to places like inland California, Arizona, and Florida.
An interesting thing to note in favor of Erdmann’s theory is that in 2017, home prices actually exceeded their pre-Great Recession peak without much fanfare from housing bubble prophets. If the prices in 2005 and 2006 were divorced from the fundamentals, it’s hard to see why prices would have so quickly rebounded and exceeded those levels.
The story of the Great Recession is still being debated over a decade later, and the smartest minds in economics have yet to figure out how to decide if something is a bubble, especially while it’s happening. That means you should be very wary of people telling you they know that something is a bubble or that it isn’t. That said, here is the case for, and against, calling today’s housing market a bubble.
The case for seeing today’s market as a housing bubble
First, prices have gone up a lot. CoreLogic’s index, a leading measure of US home prices, “recorded a 13 percent annual gain, the highest since February 2006.” Looking closer at different submarkets, it looks even more out of control: a 27.2 percent increase in Idaho, 20.4 percent in Arizona, 19.3 percent in South Dakota.
The “contagion” factor seems to be there as well, with some would-be homebuyers behaving somewhat irrationally in their desperation to get a house. People are offering to name their firstborn child after the sellers if their bid is picked; others are lining up around the block, forcing realtors to act like bouncers as “people try to cut in line,” one agent told Washingtonian magazine. And roughly two-thirds of people who bought a home in 2020 made an offer on a house that they had never seen in person.
Ali Wolf, chief economist at Zonda, explained that while there are a lot of fundamental reasons prices have increased, those didn’t all suddenly materialize in 2020. After all, she said, you’ve had “low interest rates and good demographics [millennials aging into their prime homebuying years]” for several years now, and America’s housing shortage has been a long-running issue, so why the fast price growth last year?
At least some of this could be “that frenzy, that ‘I’ve gotta go now because I’m never going to be able to buy a home if I don’t buy right now,” she said.
Another factor is the Federal Reserve’s own intervention in the market. In order to ameliorate the impact of Covid-19 on the housing market, the Fed bought over $1 trillion in mortgage bonds last year. Bloomberg reported in September that the Fed owned “almost a third of bonds backed by home loans in the US,” which has pushed mortgage rates down significantly. This provided security for the housing market and was widely seen as a stabilizing force, but it also fueled a lot of the demand and urgency people feel to buy a home quickly before rates rise again.
Unlike last time, credit-tightening standards mean qualifying for a mortgage is pretty difficult, so if we are witnessing another housing bubble and it does pop, there are likely fewer people who are at risk of default.
“That was key in 2005 and 2006,” said Bill McBride, the economics blogger who famously predicted the country had reached the bottom of the housing market in February 2012. “They would make loans to anybody!”
Since the Great Recession, it’s become harder for lower-income people to purchase a home. The median FICO score for purchasing a home is now 45 points higher than it was before the housing crash. The 10th percentile, deemed the “lower bound of creditworthiness to qualify for a mortgage,” is now 657; before the recession, it was below 600. While many have criticized these standards as too strict since they lock out less well-off Americans from homeownership, these standards have also reduced the risk that people will default on their mortgages.
Additionally, many (primarily higher-income) people have saved a lot of money after the last year. Time reported that the personal savings rate “skyrocketed to a record 32.2% in April, up from 12.7% in March, according to the U.S. Bureau of Economic Analysis.” In addition to good credit scores, homeowners have plenty of savings and have accumulated nearly $1.5 trillion in equity since the end of 2019.
This isn’t a situation where a ton of people have mortgages that they won’t be able to pay off — the marginal homebuyer is wealthier and more secure than in the lead-up to the Great Recession.
The case against seeing today’s market as a housing bubble
The case against calling this a bubble is pretty straightforward. Prices are rising primarily due to low supply. That’s paired with the demographics of the nation, which predict a huge surge in demand as millennials age into the prime homebuying years.
“I wouldn’t call this a bubble,” says McBride, the economics blogger. As the National Association of Realtors reported, millennial buyers make up the largest share of homebuyers at 37 percent. Having overtaken baby boomers as America’s largest generation in 2020, it’s no surprise that, as they reached the age when people generally begin buying homes, there would be a sharp increase in demand.
The most important factor is low supply.
Michael Neal, senior research associate at the Urban Institute’s Housing Finance Policy Center, told Vox in a December interview that low supply is “probably the biggest contributor” to the rapid rise in prices.
Having a bunch of first-time homebuyers enter the market wouldn’t be that big of a deal if the market could accommodate them. Instead, what we’ve seen is a serious failure to ensure enough houses. A Freddie Mac report found in 2018 that the housing shortage was at 2.5 million homes; in 2020, that number skyrocketed even further to 3.8 million.
It’s an especially difficult problem for first-time homebuyers like many of those entering the market over the last year, since entry-level homes make up an increasingly small share of new construction. Starter homes dropped from 40 percent of newly built houses in the early 1980s to just 7 percent in 2019, according to the same report.
The nation’s historical failure to build enough homes is not due to resource constraints (though, over the last year, the price of lumber has exacerbated the issue) but due to onerous regulations at the local level that have restricted the supply of housing in job-rich centers.
Another reason so many nontraditional markets have seen home price appreciation is because of remote work. It allowed a small portion of the population to relocate to cheaper markets where they can easily outbid locals. The stickiness around remote work will play a big role in whether this is a permanent change or a temporary brouhaha due to the strangeness of the last year.
But it doesn’t have to be all or nothing. It’s possible that there are bubbles in certain submarkets. For instance, in places where people have bought second homes for extra space during the pandemic, prices have risen as well. Post-pandemic, if demand dries up as remote work winds down, we could see prices depreciate quickly in those areas. McBride told the Atlantic these are the places he could potentially see a bubble popping.
“We might see some price declines in the second-home areas, like small towns in New England and other beach towns on the East Coast,” he said. “But even there, we just might see a shift where more people decide that they like owning second homes.”
What’s in a name? That which we call a housing bubble by any other name would be an absolute dumpster fire.
Whether we call it a housing bubble or not, the current situation is untenable.
Prices are rising, homeownership is increasingly out of the reach of many Americans, and the alternative (renting) is also increasingly expensive, especially in the most job-rich parts of the country. This is an unhealthy, unstable, and unacceptable state of affairs. And it was entirely preventable.
There aren’t enough homes to meet the demand for would-be homeowners, and there aren’t enough homes to meet the demand for renters. The US needs to build enough housing to support the number of people who need a place to live. And to do that, it needs to change local zoning laws that seek to prop up current homeowners’ investments by preventing more dense housing from being built. If it doesn’t, prices will continue to rise.
For homebuilders, knowing if demand is going to crater is important, because they don’t want to make major capital investments in submarkets where demand might change in the next year when projects may finish up. But this is also a function of America’s terrible local housing policies. There are not nearly enough places to live near the nation’s most productive job centers; the reason builders are forced to build less in certain communities is because local regulations make it impossible to build where people want to live.
This is why, for the average person, figuring out the terminology around bubbles shouldn’t be the biggest concern. The biggest concern is that when you want to move to a new job, there might not be a house to buy or a place to rent for you and your family. That when your kids grow up, there will be zero homes available nearby for them to live in. That when your parents want to downsize, or are unable to afford their mortgage on a fixed income during retirement, they’ll be forced to move out of their community because there are no available places to live.
This is a crisis of our own making. The housing frenzy that accompanies the current moment is a byproduct of turning an asset that could be widely available into a scarce one. It’s up to local, state, and federal authorities to reverse that trend quickly or face the consequences.