Will Housing Prices Ever Come Down? Comparing the Housing Bubble of the 2000s to Today

We all know someone with a story like this these days:  You find the house of your dreams.  It is in a good neighborhood with a good school district.  You are preapproved for a mortgage, and you tell your realtor to put in an offer for the full asking price.  The next day, your realtor tells you that there were five all-cash offers all over the asking price.  So you lose out on the home.  For some, this scenario has played out over and over again in the past 18 months.

From the outside, today’s housing market looks a lot like the one in 2006.  Buyers are racing to make offers on existing homes.  Developers are overpaying for vacant land, hoping to sell at a high enough price to cover their debt.  People much, much more qualified than me — like Nobel Prize-winning economists and professors — are trying to figure out why housing prices are increasing so rapidly.  And more importantly, they are trying to figure out what is coming next.

Is this a housing bubble?  Is the market going to crash again like it did in 2008?

No. The current housing situation is not like the one in the 2000s.  The differences make it less likely that the market will crash.  In contrast, I think that the local housing shortage will continue, and prices will remain high. This may last the rest of the decade.

The Housing Bubble and Crash in the 2000s

The market crash in 2008 was caused by (at least in housing terms) home buyers taking mortgages that they could not afford.  In the 2000s, buyers could get mortgages that were much greater than they could afford to pay.  Because they had more credit, they could buy bigger and more expensive houses.  This is when the term “McMansion” became part of our regular vocabulary. When these buyers could not make their payments, the housing bubble (and the subprime mortgage market that was created in its wake) burst.

There are two main differences between then and now: mortgage lending and the severe housing shortage.

The Tightening of Credit Availability

From the late 1990s to the early 2000s, millions of homebuyers bought or refinanced their homes through subprime, adjustable-rate mortgages. These were given away like Mardi Gras beads, with little or no paperwork or underwriting.

The Mortgage Bankers Association publishes the Mortgage Credit Availability Index (MCAI), which shows how easy it is for someone to get a mortgage.  The higher the number, the looser the lending standards. For the last three years, the MCAI has been between 125 and 185.  From August 2005 through August 2007, the MCAI was over 600, peaking at about 900 in March 2006.

This lending free-for-all meant that practically anyone could get a mortgage in 2006.  Today, requirements for getting a mortgage are much more closely linked to a buyer’s income and home value.  Part of this is due to the Dodd-Frank requirements and part due to the reluctance of banks to get burnt again.

In 2006, about 60% of new mortgages had subprime or near-prime mortgage loans.  But these mortgages came with adjustable mortgage rates.  Today, that percentage is about 0.1%.  When interest rates increased, combined with the oversupply of homes (explained below), buyers could not make their mortgage payments.

This overextension of credit and increasing interest rates caused huge numbers of defaults.  In 2007, the delinquency rate of subprime, adjustable-rate mortgages was between 20 and 30%. I saw newly-built communities where a quarter of the homes turned over after foreclosure, with the new owners paying a fraction of the original price.

The credit conditions that were present in the 2000s are not present today.

Today’s Housing Shortage

The second major difference between the 2000s and today is housing supply.  During the housing boom of the early 2000s, more homes were being built than were needed.  In The Supply Side of the Housing Boom and Bust of the 2000s, a Staff Report from the Federal Reserve Bank of New York, the authors suggest that between 3 to 3.5 million excess housing units were built during the housing boom.

Basic economics says that when supply exceeds demand, prices should decrease. The fact that housing prices increased during the housing boom shows that it was a temporary condition that was guaranteed to correct itself.  In other words, a bubble.

Nationwide Market

Today, there is a severe housing shortage. Freddie Mac recently found that the U.S. has a housing supply deficit of 3.8 million homes.  I could honestly quote this entire article, but this gives a good summary:

The ongoing housing shortage is large and rising, in part due to the effects of the COVID-19 pandemic. Our estimates suggest that the shortage has increased 52% from 2.5 million in 2018 to 3.8 million in 2020. And given the low mortgage interest rate environment, the high demand and the need for more space, we expect this shortage to continue into the near future. In fact, the decline in entry-level supply is even more pronounced than the overall shortage. The share of entry-level homes in overall construction declined from 40% in the early 1980s to around 7% in 2019.

This high demand has driven the housing supply shortage even higher and has also caused home prices to rise over 12% from a year ago. We do not expect housing demand to decrease in the near-term, especially given the demographic tailwind. For example, Millennials, at a population of 72 million, are now the largest demographic in the U.S., and they are at their peak first-time homebuying age – the age where homeownership soars the most.… This change is also reflected in the increase in the homeownership rate of the 25-34 year olds, which has been increasing since 2016 after recovering from the impact of the Great Recession of 2008-09…. Given the large young adult cohorts entering the housing market, the demand for entry-level single-family homes should remain high for the rest of the decade.

Lancaster Market

These nationwide trends are also true closer to home. LNP reported an 80% decrease in active home listings in Lancaster County between 2017 and 2021. Lancastrians looking to buy a house in February had 1,899 to choose from in 2017 and just 378 in 2021.

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Neither of these two points is reassuring if you are a young person trying to buy your first home.  But from a purely economic perspective, it should reduce your fear of another housing bubble and recession to follow.

The dangerous and artificial conditions that created the crash in 2008 do not exist today.