For cautious watchers of the housing market, familiar patterns in the data have raised cause for concern. Should we be worried about another housing bubble crash? Experts say probably not.
At a panel discussion on October 15 hosted by the Columbia University School of Professional Studies M.S. in Enterprise Risk Management (ERM) program, moderator Bruce Fox, head of derivatives and tactical investment strategy at Genworth Financial, shared several yellow flags that seem to indicate a looming housing bubble: Home prices have gone up almost 10% per year over the the past five years, roughly double what they have been since the start of the Case-Schiller in 1987. Fannie Mae reports that housing sentiment is the highest it’s been in over two years. Home prices are high relative to rents and incomes. And the National Association of Realtors Housing Affordability Index is at an all-time low.
Despite these potential warning signs, panelists were unanimous in their prognosis that safeguards and structural changes since the financial crisis of 2007–2008 make a similar crash unlikely, with a relative return to equilibrium in housing price growth expected moving forward.
In his forecast, Cris de Ritis, deputy chief economist at Moody’s Analytics, noted that while we currently are facing a serious affordability challenge, he predicts a moderate reduction in mortgage rates to around 6%. More housing inventory should come back into the market and, combined with additional construction projects, should add downward pressure to bring us back on track toward a more sustainable housing market. That price trend will likely be flat for a while, but should eventually return to a normalized growth rate of 4–5%.
Panelists largely agreed with de Ritis’s assessment. Pratik Gupta, managing director and head of global CLOs and US RMBS strategy at Bank of America Securities, seconded the opinion that the expected increase in inventory of existing homes would likely add downward pressure on price growth, and lead to a leveling off at around 3.5 to 4% growth in the Case-Schiller Home Price Index over the next 12 months. However, he shared a caveat that there remained a risk factor in certain regional markets, particularly in relation to large climate events. Gupta noted the two recent hurricanes that hit Florida particularly hard, adding: “Insurance costs are starting to have a bigger impact on consumer wallets, especially in areas like Florida, where hurricanes occur with greater certainty.”
Laurie Goodman, institute fellow and founder of the Housing Finance Policy Center at the Urban Institute, agreed with Gupta’s footnote about regional variance but offered an explicitly optimistic outlook for the market overall. She noted the acute lack of housing supply in the market, in stark contrast to the situation before the financial crisis. Ever since the market crash, she said, we’ve been “underbuilding” new constructions. Goodman cited a shortage of between 1.7 and 5.5 million housing units, relative to demand. She is also skeptical of the common belief that high interest rates directly cause low affordability and in turn will lower home prices. Goodman noted that, historically, there is a slightly positive relationship—higher interest rates are actually associated with higher home prices. That’s because they are associated with a strong economy and higher inflation, which outweighs affordability concerns. The only times home prices declined, she explained, were during recession periods.
On the topic of resilience of the current market, Dan Thakkar, chief investment officer of Chimera Investments, also contrasted the current situation with that of the pre-financial crisis market. He highlighted the proliferation of collateralized debt obligations (CDOs) and synthetic CDOs which produced a “leverage on leverage situation” that is no longer rampant in the current market. Whereas the Combined Loan to Value (CLTV) ratio—determined by adding the balances of all outstanding loans divided by the current market value of the property—back then was “north of 90%, if not all the way to 100%,” today, the CLTV ratio is estimated around 80%.
The panelists referenced the Dodd-Frank Wall Street Reform and Consumer Protection Act and other precautions taken by lending financial institutions to ensure that they are dealing with reputable borrowers, which significantly decrease the likelihood of widespread defaults and crashes.
Gupta also added that servicers these days are more proactive to ensure borrowers have alternative payment options if faced with a major credit event such as a job loss or medical issue. This “solutions era-based time we live in,” he added, “means foreclosures are a lot less [frequent], and that has an impact of reducing supply during times of distress” like recessions.
About the Program
The Master of Science in Enterprise Risk Management (ERM) program at Columbia University prepares graduates to inform better risk-reward decisions by providing a complete, robust, and integrated picture of both upside and downside volatility across an entire enterprise.
