Are We in Another Housing Market Bubble?

As of May this year home prices had increased 7.1% since May 2017, the biggest increase in 4 years ( This leaves many people asking, are we in another housing market bubble?

Historical Trends

Figure 1 depicts the US House Price Index. The lower red line follows the growth rate between 1975 to 2000. The upper red line shows how far we have deviated from the 1975 to 2000 sustained growth rate. As you can see, we are following a very similar trend to the last bubble. The yellow portion is an overlay from the crown of the last bubble to illustrate what might happen if we continued to follow the last trend. The vertical red line marks the apex of that trend at early 2020.

Figure 1 – All Transactions Home Price Index for the United States 

It is important to realize that real-estate hasn’t historically followed a cycle of booms and busts like the equities market. Therefore, while this graph looks very concerning, we should not necessarily conclude that 2007 will repeat in 2020. In-fact, 2007 was the first time in history the US saw a nationwide decrease in home values.

Supply and Demand

To understand bubbles, it’s important to understand how home prices fluctuate in a market. Like any good or service, home prices are a function of supply and demand. The main factors that affect supply of homes on the market are new construction, people moving out of the area, moving up or downsizing, and bank-owned houses for sale. Supply is more volatile on a local level because people can move in and out of a city or state freely, but it is more difficult to move between countries. The factors that affect demand are people moving into an area, affordability of buying compared to renting, and the expectancy of prices to rise. Affordability is determined by the price, available interest rate, and lending standards.

The Effect of Mortgage Rates on Demand

Mortgage rates have a massive effect on the ability of borrowers to purchase, and therefore the demand for homes. On October 6, 2016, 30-year fixed interest rates were 3.42%. If you could afford a mortgage payment of $2,000, you could borrow up to $449,852. On October 11, 2018, interest rates rose to 4.9% (Figure 3). With that same payment of $2,000, you could only get a loan up to $376,859.

Generally, a lender does not like to see a person’s total debt payments as more than 36% of their income (Investopedia). This means your monthly income would need to increase by $1,075 to afford the $449,852 mortgage in 2018. When income growth does not keep up with increases in interest rates people can’t afford to buy as expensive homes as they could have in the past. Likewise, a lender loosening or tightening their standards as to your debt-to-income ratio can make a big impact on a borrower’s ability to purchase.

What Really is a Bubble?

“The term ‘bubble’ is widely used but rarely clearly defined” (Case & Shiller). If you look at where we are now on the Home Price Index graph it looks like we are approaching the top of a bubble, but a bubble isn’t so much about the trend as it is the cause. Most economists define a bubble as expected future price increases causing speculative purchasing and inflating the market prices temporarily.

What Happened in 2000-2007

The early 2000s was the perfect storm for a mortgage crisis. 30 Year Fixed Mortgage rates lowered from 8.6% in May 2000 to 5.21% in June 2003 (Figure 3). While this doesn’t sound low compared to now it’s historically very low. This allowed more people to buy houses. A high demand for mortgage-backed securities also caused very loose mortgage lending standards. People with poor credit history, low income, and low or no down payment could qualify for subprime loans.

The increased availability of financing increased demand and drove up home prices. Increasing home values gave a false sense of security to both lenders and borrowers compounding the situation and causing even lower lending standards. Lenders would offer “Stated Income Loans” without any income verification and many people would lie about their income. People also got loans with lower introductory rates and adjustable rate mortgages. Some lenders would even offer negative amortization mortgages because everyone believed the market would continue to go up and nobody wanted to miss out on the appreciation.

New home building permits surged from 2002 to almost record highs in 2005 (Figure 9). Many people bought as many houses as they could, overextending their finances. At the time, values were going up so quickly that people could take out a home equity line of credit to pay their mortgage. Many people thought they were making a ton of money off the appreciation.

An increase in interest rates from 5.62% July 7 2005 to 6.63% August 2006 (Figure 3) began to tighten up financing availability and was detrimental to many people with highly leveraged adjustable rate mortgages. Appreciation slowed down from the 4th quarter of 2005 to the first quarter of 2007 (Figure 1). Supply of houses began to catch up. Introductory rates on mortgages began to expire and payments went up. Many people couldn’t afford the payments. Mortgage defaults shot up which caused lenders to tighten their standards and tightened back the availability of financing (Gooch). In the second quarter of 2007 prices began to fall (Figure 1).

What has Driven Prices Back Up?

Figure 2 below shows the home price index again in blue, but this one also has the consumer price index. It’s interesting to see that home prices outperformed other goods and services at a relatively constant rate from 1975 to 2000 but changed after 2000. The trough in 2012 hits about where prices would have been if they had followed their previous projection, but they have shot up again- so what’s driving that growth?

Figure 2 – Consumer Price Index compared to Home Price Index

Mortgage Rates Caused Increased Demand

As you look at figure 3 you will see that in the period since the recession, we have had record low mortgage interest rates below 5%; this has increased affordability and thus increased demand for housing.

Figure 3 – 30 Year Fixed Mortgage Average in the United States

Tight Inventory Drove Up Prices

When supply is low scarcity drives up the price. Figure 4 shows the number of houses on the market. You can see that in 2013 the supply of homes on the market reached its lowest. That’s when prices started to recover again.

Figure 4 – National All Homes for Sale by Redfin

REO Inventory Has Dried Up

Compare figure 4 with figure 5 and you will realize that there was a major correlation with the number of foreclosed properties and the properties available for sale. In January 2009 28% of homes on the market were REOs. By the middle of 2016 that number dropped to 5% (Market Watch).

Figure 5 – Foreclosed Properties by RealtyTrac (From Market Watch Article)

Home Builders Put Out of Business

While the demand for housing is back, many of the builders who were put out of business during the crash are not. During the crisis 1.5 million construction workers were laid off and barely half that many have been replaced since (Market Watch). With the REO inventory gone and not enough builders to meet the demand, home prices have been pushed up.

Americans Staying in their Homes Longer

Many Americans are staying in their homes longer because they lost a lot of equity in the crash and it’s not worth it to move, or there aren’t enough homes on the market and they can’t find another one to buy. Before the crash it was normal for people to stay in a home for six years. In 2016 and 2017 sellers had stayed in their home for a median of 10 years (Market Watch).

Increase in Home Sizes

Figure 6 shows that the median and average sizes of new homes being built grew considerably since the crash. This is another factor that contributes to the increase in sales prices.

Figure 6 – Size of Single Family Homes from National Association of Home Builders

When you compare Figure 6 with Figure 1 or 2 you will notice they look very similar, indicating that the increasing size of new homes is a factor in the median sale price of homes.

Around 2014 new home sizes began to decline. However, prices have continued to increase steadily, likely because interest rates lowered (Figure 9) and inventory began to tighten up after 2005.

Where are We Now and What’s next?

It’s been an interesting year. Home prices really boomed in the spring, but we have felt a softening in the market in the fall especially in the upper middle and up valued properties here in Utah. It’s no secret that real estate is seasonal. Most families would prefer to move in the summer when the kids are in school, and most people would avoid moving during the holidays.

Figure 7 shows a more detailed monthly view of median home sale prices compared to FREDs quarterly numbers. It is interesting to observe the seasonal trend. You can see that since 2013 sale prices have hit their peak mid-year in the summer and hit the bottom around the new-year’s. You will notice that for the past three years the trough at the end of the year was about the price level of the summer of the year before (18 months back), but this year when September’s numbers came out they showed a significant hard and fast drop. The price in September was already down below that of June 2017. I wondered if it was the recent jump in interest rates pushing down prices.

Figure 7 – National Median Sales Price by Redfin

To be thorough I compared with the median price per square foot graph to see if it dropped as well. Interestingly the median price per square foot increased in September. This indicates that the houses sold in September were likely smaller houses, as smaller houses tend to have a lower price but a higher price per square foot.

Figure 8 – National Price Per Square Foot by Redfin

Building permits are near the highest they have been since the crash but are still only about 55% of where they were at the peak. This is because, as discussed earlier, many builders went out of business during the crash. The positive side is we probably do not need to be worried about speculative “overbuilding” which contributed to the crash in 2007.

Figure 9 – New Private Housing Units Authorized by Building Permits by FRED


The US Housing Affordability Index (Figure 10) is calculated by comparing median single-family home prices to interest rates and median household qualifying income. While prices have risen a lot, national affordability is still relatively high.

Figure 10 – US Housing Affordability Index by the National Association of Realtors, 2018 Data added by Joel Finnie

Debt Service to Income is Low

Another positive thing to note is that household debt service payments as a percentage of disposable income are extremely low right now compared to its highest point right before the last crash. This makes me very optimistic because high levels of debt played such a big role in that crash.

Figure 11 – Household Debt Service as a Percentage of Disposable Income


While prices appear high, nationwide affordability is still high. Interest Rates are expected to rise to 5.2% by 2020 (Mortage Bankers Association), which shouldn’t affect affordability too adversely. According to JP Morgan we have a 60% chance of a recession by 2020. When the next recession comes unemployment will rise. We may see prices pull back a little in big cities where very strong employment has driven up prices, and we may see some delinquencies rise in certain areas. However, I believe a nationwide decline in home prices is extremely unlikely and would require something catastrophic.

Lending standards are conservative, borrowers are not overleveraged like in2007, ARMs are rare, and new building permits are still only back to 1994 levels. The prices are high because the inventory is low, and it will take time to build more inventory. I think overall prices will continue to rise but at a slower rate than they have since 2013. Price growth in the middle and upper range will likely slow more than entry level homes as entry level supply is tightest.

Works Cited

“30-Year Fixed Rate Mortgage Average in the United States.” FRED. November 01, 2018. Accessed November 06, 2018.


“All-Transactions House Price Index for the United States.” FRED. August 24, 2018. Accessed November 06, 2018.

Gooch, and Fredric J. “Building on More Solid Ground: The Mortgage Industry Is Reeling from a Period of Bad News and Market Excess That Has Triggered an Ongoing Response from Lawmakers and Regulators. What Some Have Called a Market on Steroids Has since Come Crashing Down to Reality.” “Building on More Solid Ground: The Mortgage Industry Is Reeling from a Period of Bad News and Market Excess That Has Triggered an Ongoing Response from Lawmakers and Regulators. What Some Have Called a Market on Steroids Has since Come Crashing Down to Reality” by Gooch, Fredric J. – Mortgage Banking, Vol. 67, Issue 12, September 2007 | Online Research Library: Questia. Accessed November 06, 2018.

“Consumer Price Index for All Urban Consumers: All Items.” FRED. October 11, 2018. Accessed November 06, 2018.

“Housing Affordability Index.” Accessed November 06, 2018.


Jurow, Keith. “Why the U.S. Housing Recovery Is Built on Quicksand.” MarketWatch. October 18, 2018. Accessed November 06, 2018.

Jurow, Keith. “Why the U.S. Housing Recovery Is Built on Quicksand.” MarketWatch. October 18, 2018. Accessed November 06, 2018.

Jurow, Keith. “Why the U.S. Housing Recovery Is Built on Quicksand.” MarketWatch. October 18, 2018. Accessed November 06, 2018.

“New Private Housing Units Authorized by Building Permits.” FRED. October 24, 2018. Accessed November 06, 2018.

Olick, Diana. “Home Prices Make the Biggest Jump in Four Years.” CNBC. July 03, 2018. Accessed November 06, 2018.

Orton, Kathy. “Experts Weigh in on What the 2018 Housing Market Will Bring.” The Washington Post. January 08, 2018. Accessed November 06, 2018.

Redfin Real-Time. “Data Center – Redfin Real-Time Housing Market Data.” Redfin Real-Time. Accessed November 06, 2018.

Riquier, Andrea. “Why Aren’t There Enough Houses to Buy?” MarketWatch. September 01, 2017. Accessed November 06, 2018.

Riquier, Andrea. “‘I’m Never Moving Again’: Why Americans Are Staying in Their Homes for Longer.” MarketWatch. October 30, 2017. Accessed November 06, 2018.

Posted on November 5, 2018 at 12:31 pm
Joel Finnie | Category: Uncategorized

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