Housing crash? Or will prices jump 3 times in next 15 years?

Our generation of investors and home buyers have just come out of a major real estate crash in 2008 and we are very cautious due to the recency bias. The current economic and societal events in our eyes look unprecedented and hard to make sense of. Looking back in time usually provides a degree of comfort, however, looking back 10 or 20 years in the current situation does not provide any sense of resemblance to what we have going on now. Here we zoom out even further, looking at the real estate price dynamics going back to 1890. We find a remarkable similarity between the current situation and the way things were 100 years ago, highlighting that, perhaps, the generational theory described in “the 4th turning” by Neil Howe and William Strauss might play out this time as well.

We are looking at the unadjusted case schiller home price index. Adjusting for inflation, one may argue, is meaningless since there is so much controversy with CPI and arguments if the inflation data is even real, or is it manipulated and not meaningful. Therefore, we look at the housing index in nominal terms. To get an idea of a “real” index, we compare it to the M2 money supply.

The Case-Shiller Index is made up of several indexes that track the value of single-family detached residences using the arms-length and repeat-sales methods. Here we look at the residential consumer related housing prices. Investment real estate will be subject of a later discussion.

Case Schiller unadjusted index looks like a hockey stick and doesn’t make much sense on the linear scale. Inflation adjusted case schiller index makes even less sense (that is why we ignore it here). We first see and good correlation between case schiller and M2 money supply. As we discussed before, if we replot M2 on log 10 scale we will see a perfect straight line. We replot case schiller on same scale and compare with the M2.

From 1890 until 1990, for 100 years, we see that M2 supply is outpacing price growth of housing. Only in 1990 it starts to grow with the M2. It is almost as if it was somehow suppressed in 1890-1990. Reality is the opposite: until mid-late 20s century the housing market has just not yet been fueled with multiple loan options and increasing size of mortgage market.

1890-1917 prices were flat for almost 30 years. Mortgage market was not very developed. Most loans required 50% down payment, they had no amortization, and they had 5 year maturity with a balloon payment. By 1920s prices ticked up 30% fueled by roaring 20s and the market exuberance, following by a massive housing crash during the Great Depression. As a result of the turbulence of the 30s, political climate and social sentiment a package of progressive policies was introduced, that included creation of the FHA in 1934 (The New Deal). FHA helped crease a more modern mortgage with 10-20% down and 15-30 year amortization.

In 1938 Fannie Mae was created that purchased FHA secured loans and then sold them on secondary marked, pouring liquidity into the mortgage sector. In 1944 a VA was created allowing veterans to buy homes with 0% down and low interest rates. These new loan products and new liquidity made houses much easier to buy, and lead to a massive 300% housing price increase in 15 years between 1940 and 1955.

Next 15 years, from 1955 to 1970 prices grew much slower, increasing only 40%, until, in 1970 Freddie Mac was created. Freddie Mac, like Fannie Mae, also bought and sold loans on open marked, further increasing liquidity and making homes easier to buy. Difference between Freddie and Fannie is that Freddie bought loans from smaller banks, while Fannie bought from larger banks. As a result of Freddie creation and also ARM introduction in 1980, in the next 15 years prices jumped again 300% from 1970 to 1985.

The next 15 years saw a slower growth again, with a relatively minor price pull back in late 80s, showing 80% price growth from 1985 to 2000. However, a new government initiative was adopted in the 90s with the goal to increase home ownership rate to 70 %. As a result of this initiative, new loan products emerged: the subprime loans, 80/20 loans and option ARM loans (where buyer owed more at the end of each month). As before, these new loans made houses much easier to buy, leading to 200 % price increase in 10 years from 1997 to 2007. After 2007, we all know what happened.

So where are we now? From 2007 next 15 years until 2022 made people lose everything and also made people fortunes in real estate. What we see now is that the housing price growth is more correlated with M2 than before and also that it is offset from M2 due to 2008 GFC. As housing prices fell from 2007 to 2012, money printing never stopped. Housing prices have been lagging behind money creation since 2007.

In the 2010s we have seen massive money creation by commercial banks and also the Federal Reserve through many QE cycles, which poured liquidity into the markets, while also keeping interest rates at historic lows. On top of this, the 2020 events, even more money creation and even lower interest rates made houses much easier to buy (high buying power). This is a similar environment to 1930s that lead to 300% price boost, and in 1970s, that lead to another 300% price boost. Are we in for another 300% price increase by 2035?

I don’t know. But I will show one last chart showing mortgage payments as percentage of disposable income that approached all time low in 2021 (high staying power).