Sheila Bair, who had a front row seat to the subprime mortgage meltdown, is worried today’s housing market is unsustainably hot.
The median home price of an existing home stood at just $278,200 in August 2019, according to the National Association of Realtors. That figure has since spiked to $407,100 as of August 2023.
“Talk about a bubble. That’s a classic supply-demand imbalance,” Bair told CNN in a phone interview.
Bair, who served as a federal regulator when the mid-2000s housing bubble popped, nearly taking down the entire financial system, said home prices today are “bubbly” following years of rock-bottom mortgage rates.
A housing bubble can form when prices rise to unsustainable levels. This can be caused by speculative buying, as was the case during the sub-prime mortgage crisis when people who could not make the monthly payments on their mortgages were buying homes with very little money down. The bubble popped when home prices dropped and many people owed more on their home than it was worth.
A bubble can also be caused by irrational exuberance, in which a surge in prices leads to a buying frenzy.
“When rates were cheaper, a lot of people wanted to buy. You ended up with really frothy price increases. That was pretty predictable,” said Bair, who led the Federal Deposit Insurance Corp. from July 2006 until July 2011.
Although Bair said home prices need to correct downward, she’s not confident that will happen anytime soon because there’s still a shortage of homes on the market and she doesn’t expect the bubble to violently burst.
“If supply remains constrained, this could go on for some time,” said Bair, who last week released a new children’s book about bubbles called “Daisy Bubble: A Price Crash on Galapagos.”
There were just 1.1 million existing unsold homes on the market as of the end of August, down 14.1% from the year before, according to the NAR.
‘Letting that bubble deflate’
The one-two punch of surging home prices and high borrowing costs have made it very difficult for many Americans to afford to buy a home today.
Despite mortgage rates surging to an average of 7.49%, some cities are still experiencing rapid home price gains.
Over the past year, the median home price has increased by 23.8% in Los Angeles, 18.2% in San Diego, 15% in Richmond and 14.6% in Cincinnati, according to Realtor.com.
“Letting that bubble deflate a bit would probably be a good thing,” said Bair. “People who already own their home – and I’m one of them – don’t want to hear that. But for those who want to own, I hope home prices do come down.”
The good news is Bair does not see a repeat of the bursting of the mid-2000s housing bubble, which set the stage for the Great Recession. That’s in part because a typical homeowner today has more equity in their homes than a homeowner during that time. Only 1.1 million homes, or 2% of all mortgaged properties, owed more on their mortgage than their home was worth in September, according to CoreLogic. That is a small number compared with the share of properties underwater during the sub-prime mortgage crisis, which topped out at 26% in the fourth quarter of 2009, according to CoreLogic’s equity analysis, which began in the third quarter of 2009.
In addition, mortgage lending standards are significantly tougher today, meaning fewer people are borrowing more than they can afford.
“I see much less speculation in the housing market today, thank goodness,” said Bair.
And unlike in the mid-2000s, homeowners today have built up a significant cushion of equity. That means they shouldn’t find themselves in a situation like during the subprime meltdown where many owed more than their homes were worth.
“Even if home prices adjust a bit, people should not be under water,” said Bair.
Legendary investor Jeremy Grantham shares Bair’s concern about a housing bubble. He has been warning of an eventual plunge in home prices around the world.
“Real estate is a global bubble,” Grantham said on The Compound and Friends podcast last month. “Home prices will come down…30% would be a pretty good guess.”
Yet others on Wall Street are confident home prices will continue rising.
Despite high mortgage rates, Goldman Sachs expects US home prices will increase by 1.8% this year and then accelerate to 3.5% growth in 2024. Similarly, CoreLogic forecasts that home prices will increase by 4.3% from June 2023 to June 2024.
Although UBS acknowledges home prices have spiked to “dizzying heights” in recent years, the bank only sees two cities around the world at risk of being in a bubble: Zurich and Tokyo. That’s down from nine cities a year ago.
Miami, Los Angeles, Toronto and Vancouver are among the cities that UBS says are in “overvalued” territory.
Fannie Mae CEO Priscilla Almodovar said it’s “unusual” that home prices have not taken more of a hit from high mortgage rates.
“What has surprised us the most is the stickiness of home prices,” Almodovar told CNN in a recent interview. “Supply is the issue. There is no place to go. There is a lack of inventory.”
That’s the main reason Lawrence Yun, chief economist at the National Association of Realtors, says homebuyers shouldn’t hold their breath waiting for a drop in home prices.
“There is not going to be a home price crash,” Yun told CNN. “When you have a housing shortage, home prices simply cannot decline in any measurable way.”
While a temporary dip in prices is possible, Yun said a “prolonged” drop of 10% to 15% “cannot happen in this tight supply market.”
Yun noted that many assumed London was in the midst of a housing bubble years ago – only to see prices continue to rise, albeit with fewer people participating.
“It became only a playground for the wealthy. I hope America doesn’t go in that direction,” he said.
In many ways, today’s housing market is the polar opposite of the one that preceded the Great Recession.
Back then, reckless mortgage lending helped create a situation where demand became artificially strong. Eventually, it collapsed and the market was left with way too many homes.
“Today, we have an imbalance the other way. Too much demand, not enough supply,” said Yun.
The NAR has estimated the supply of homes needs to basically double to moderate home prices.
“It’s creating social inequity. The only way out of this situation is we have to induce more supply,” said Yun.