Housing market pessimists have been sounding the alarm for years about a pending crash in the U.S. residential real estate market. Even before the Federal Reserve began hiking interest rates to fight inflation last year, pushing mortgage rates to a 23-year high this month, years of surging home prices left some experts warning that the housing market was a massive bubble ready to pop.
However, despite a widely bearish outlook in the industry, most real estate veterans have avoided arguing that home prices will drop like they did during the 2008 crash that kicked off the Global Financial Crisis (GFC). And so far, that’s been a wise decision.
It took until June 2022 for national home prices to peak, even as mortgage rates soared and purchase applications plummeted amid the Fed’s first interest rate hikes. And while prices fell more than 5% from that peak by January of this year, they returned to a record high in July.
Still, a Bank of America team led by U.S. economist Jeseo Park warned this week that there’s more “turbulence” coming for the housing market due to high mortgage rates. They explained that they’re getting an eerie feeling of “déjà vu,” but it’s not 2008 that is coming to mind, it’s the 1980s.
“Looking back at previous housing recessions, we think the 1980s are a better analogy for today's market than the 2008 housing crash,” they wrote in a Thursday note.
This isn’t 2008
While the housing crash of 2008—fueled by the collapse of subprime mortgages—haunts the memories of many Americans, the real estate market of that era was very different from what Bank of America’s experts see today.
Park and his team noted that there are no “noticeable signs” of excess housing development today like there were back then, and households aren’t nearly as burdened by mortgage debt. Household mortgage debt represented roughly 65% of U.S. consumers’ disposable income in the second quarter, compared to 100% before the GFC. And the ratio of Americans’ mortgage debt to their real estate assets—also called loan-to-value—was just 27% in the second quarter, compared to over 40% in 2008 and roughly 50% in 2010, Bank of America’s data shows.
New legislation was also enacted since the GFC to help prevent worst-case scenarios in the housing market. One of the most obvious effects of these new laws is that there are far fewer risky adjustable-rate mortgages today. Adjustable-rate mortgages can lead to higher default rates when interest rates rise, but they now represent less than 5% of total purchase and refinance loans, compared with over 35% at the peak of the pre-GFC housing cycle.
“We reiterate that we do not expect another housing crash like 2008,” Park and his team concluded after presenting this evidence.
Is it a repeat of the ‘turbulence’ of the 1980s?
According to Bank of America, today’s housing market looks a lot more like the early 1980s than it does 2008. Back then, just like today, home prices had boomed for years before Fed officials were ultimately forced to hike interest rates aggressively in an attempt to fight inflation.
The rise in the consumer price index peaked at around 14% in 1980 before then–Fed Chair Paul Volcker’s hawkish policies sent mortgage rates to 18% in a year’s time, cooling inflation, but sparking a recession. This caused a serious downturn in the housing market in which home sales and building levels cratered. However, national home prices actually remained stable.
At the start of Volcker’s term as Fed chair in August 1979, the median U.S. home sales price was $64,700. And even after a near doubling of mortgage rates, that figure rose to $69,400 by the second quarter of 1981.
Over the past 18 months, the Fed’s current chair, Jerome Powell, has been following a very similar game plan to Volcker's, raising interest rates aggressively to quash inflation. The average 30-year fixed mortgage rate, the most common type of mortgage in the U.S., has soared from 3.8% in March 2022 to over 7.5% today as a result. This, in turn, has slowed mortgage purchase applications and caused home sales to plummet, just as it did in the ’80s; but home prices, echoing the dynamic of that era, have yet to collapse.
One of the key reasons for the resilience of the housing market in both of these periods is demographics. “Noticeably, demographics were favorable back then, with baby boomers having entered the prime homebuying age,” Park and his team wrote Thursday, arguing millennials are in a similar position today. “Some sales activity should be supported by millennials reaching the prime homebuying age, and single-family building permits have steadily held up. This can help the housing market retain some of its momentum without falling apart.”
Bank of America economists believe that low inventory of existing homes for sale combined with solid home sales to millennials could help put a “floor beneath home prices,” but that doesn’t mean there won’t be some near-term pain due to higher mortgage rates.
“With rates likely staying higher for longer, we are cautious of potential turbulence ahead,” the group warned. Bank of America has previously forecast 0% home price growth and falling home sales for the full year 2023, but it didn’t offer a new prediction in its latest note.
Eventually, as inflation fades leading the Fed to cut interest rates, housing affordability will improve. “At that stage, we should see a more stable and healthy housing market,” Park and his team wrote. “Until then, hang tight, it may be a bumpy ride.”
