Robert J. Shiller, a Nobel Laureate and professor of economics at Yale University, appears deeply concerned about the U.S. housing market. In a recent op-ed, Professor Shiller warned that the U.S. was experiencing one of the greatest housing booms in its history.
What concerns Professor Shiller is that the boom cannot go forever. But when the boom will end is anybody’s guess. Also, how the boom will end is again far from certain. Will there be a gradual decline or a catastrophic collapse of housing prices? Only time will tell.
While one might be tempted to invoke similarities with the housing-induced Great Recession just 10 years ago, one must consider the dissimilarities as well. Housing prices are sharply rising — that is true. But the other co-enablers of the last financial crisis — namely the proliferation of subprime mortgages, collateralized debt obligations, high domestic indebtedness, and speculative housing construction, to name a few — are missing or not as acute.
Could housing price inflation alone be enough to bring the housing market down?
Professor Shiller is respected for his deep insights into the markets. He foresaw the adverse consequences of “irrational exuberance,” which he later detailed in a book by the same name. The S&P/Case-Shiller National Home Price Index, which bears his name, demonstrates his indelible mark on how the housing markets are viewed and understood.
He is also among a handful of experts who in 2005 foretold the housing market meltdown that contributed to the Great Recession in 2008-09. Ignoring Professor Shiller’s concerns is always unwise. At the same time, it is imprudent to panic or start betting against real estate markets in knee-jerk fashion. A sensible approach would be to determine whether the U.S. housing market is defying economic fundamentals and, if that is the case, whether the housing market is heading for a soft landing or a precipitous decline.
According to the Case-Shiller Index, current (nominal) housing prices in the U.S. are 53 per cent higher than prices in September 2012, when they hit rock bottom, an increase that was achieved in part even as interest rates were on the rise. Current prices are also 11 per cent higher than their peak in 2006.
The calls for concern thus seem warranted.
But then there are differences between the current price escalation and the one seen in the mid-2000s. Housing prices are increasing now at a slower rate than they did in 2005. Over a six-year period, nominal housing prices in 2005 increased by more than 90 per cent. Before the markets collapsed, housing prices appreciated by over 14 per cent annually.
Since 2015, U.S. housing prices have increased at around five per cent annually, which is at a much lower rate than in 2013 when the annual increase in prices was more than 10 per cent. The two- and three-year increase in current housing prices also seem to be stable since 2015.
Similarly, the delinquency rate on single-family residential mortgages has been in decline since hitting a peak in 2010, though the current delinquency rate remains higher than pre-Great Recession levels.
Also, seasonally adjusted annual U.S. housing starts, which reached more than two million in 2006, are currently much lower at around 1.3 million units. The present housing supply response to increasing housing prices is therefore muted. Any excess supply of housing, which could exasperate a decline in housing markets, is not as pronounced now than it was earlier.
At the same time, household debt levels in the U.S. have been at their lowest since the early eighties. In the best-seller House of Debt, Professors Atif Mian of Princeton University and Amir Sufi of the University of Chicago explained how a huge increase in household debt before the Great Recession was followed by a “significantly large drop in household spending.” Their research showed that “excessive household debt leads to foreclosures” in the housing market.
Household debt levels in the U.S. are not as acute as they were in the fourth quarter of 2007 when household debt payments as a per cent of disposable personal income reached a high of 13 per cent. The same metric has averaged under 10 per cent since 2014.
For U.S. housing markets, 2019 will be an interesting year. Professor Shiller warns that housing prices cannot grow forever. One cannot know for certain when prices will level off. However, the differences between current economic fundamentals and the ones that immediately preceded the Great Recession suggest that it will unlikely be a catastrophic plunge. Only time will tell.
Murtaza Haider is an associate professor at Ryerson University. Stephen Moranis is a real estate industry veteran. They can be reached atwww.hmbulletin.com.