On The Verge Of A Different Kind Of A Housing Crisis

by: Zoltan Ban

Median house prices increased at a far higher pace than median household incomes in the past few decades, helped along by the long-term trend of declining interest rates.

Despite lower interest rates, current house ownership affordability seems to be a challenge for the newer generations of young homeowners.

The process of moving back towards historically more normal household incomes to house price ratios may have begun last year.  Process will last decades and will leave middle class feeling impoverished.

The AAA-rated subprime mortgage crisis is long behind us now. House prices have seen a substantial recovery, with median home prices now far surpassing the heights we reached back in 2007. What we thought then to be inflated prices, now look rather tame, given that the median sale price of a home is currently $317,000, which is almost 25% higher compared with the peak reached in 2007.

US median house prices Source: Federal Reserve Bank of St. Louis.

By comparison, median household incomes increased by slightly less than 25% since then. Median incomes in non-adjusted terms increased by less than 50% so far this century, while the median price of a house has doubled. What this means is that the median household will find that a median house today is slightly less affordable than it was in 2007, while compared with two decades ago, a typical family will take in a far higher mortgage debt ratio compared to their income. None of it would be possible of course, if it were not for the much lower mortgage interest rates we are experiencing. In effect, we are looking at a return to the 2007 situation, this time not fueled by sub-prime mortgages, but rather by low interest debt. That by itself should be reason to worry, but there is so much more to it than that, which makes the possibility of another housing crisis very likely.

Another housing crisis would not be a repeat of the old one, but could be with us for a long time.

Just so we are clear, I am not suggesting we will see another 2008-style financial near-Armageddon, with endless personal bankruptcies leading to banking failures and massive bailouts, which will in turn cause a severe recession. What I do envision is a longer-term crisis, which will not necessarily be the trigger for any particular crisis event, but rather contribute to the gradual erosion of the economy's overall health, which is already an ongoing event. What this means is that when a crisis will hit, due to any number of possible factors, we will be facing the crisis in a weaker position. Any recovery will also be more tame as a result.

Risk of eroding real net worth for most in the middle class.

Median house prices peaked once more in the fourth quarter of 2017 and have been on a down-trend since then. In the view of many people, this may be just sort of a necessary, healthy correction, while the overall longer term trend is still one where house prices will at the very least keep pace with inflation. I think there are reasons to expect for this not to be the case, and that should become more obvious if we focus in on the state of new buyers, namely young people entering the workforce.

Student loan debt is one of the factors which is likely to make it much harder for young families to afford a house.

Source: Marketwatch.

As we can see, in just over a decade, total student loans have tripled. What this means to average young families, many of which contain at least one student debt burden, is that they are starting off in life already heavily in debt. The average student loan debt of a fresh college graduate is $37,000. If two average recent college graduates get married, it is more than likely that their net household income for a year will barely equal their student loan debt burden. If we add to it car loans, as well as other personal debt, more and more young people start off life paying the equivalent of a mortgage on a modest home, even before they purchase an actual house.

We should also take note of the fact that younger people entering the workforce are increasingly faced with a lack of job security and under-employment issues, which combined with them already being in debt, adds up to the current generation that is entering adult life being perhaps the least prepared to take on a mortgage since the end of the Second World War. This has been the case for a while now, but low interest rates helped to close the affordability gap that is growing between the housing market and the young millennial buyers. At this point however, there is not much more that interest rates can do for the housing market in terms of helping to support continued price growth. That is why we are now seeing a decline in median house prices, in lockstep with the moderate increase in mortgage interest rates.

House prices may resume a trend of rising prices eventually, but in my view, there is very little price support, given the diminishing ability of young households to carry a mortgage. Prices may rise, but in the long term the increase will average less than inflation, and less than median household income growth, which itself is set to be moderate going forward. The way I see it, we will have to converge back to the kind of affordability rates we had near the beginning of the century. back then the median house price was 3.9 times median household incomes. As of 2018, we are at 5.3 times median household incomes.

US median income versus median house price ratio

Data sources: FRED, FRED.

A recent study showing that about 70% of millennials regret buying a home suggests that things are far from alright in regards to the longer-term health of the US housing market. This is especially the case if we look at the reasons for that regret. One in three lament the fact that they dipped into their retirement fund in order to make the down payment. As I pointed out already, younger generations are in a less than ideal financial position, given other financial pressures, which is what leads to this financially less than sound move. Ongoing costs of maintenance also seem to hang heavily on young families according to the same survey. In other words, millennials can only handle part of the ownership burden of their house, namely mortgage, utilities, and taxes, but having to also take care of ongoing maintenance of the house is one burden too far.

Because new generations of Americans are increasingly unable to cope with the total cost of home ownership, there will be more and more people renting, whether it is a home or an apartment. This will cause demand for single home ownership to soften from this point on, regardless of whether we keep interest rates low or not. What this means for those 64% of all households who own a home is that they are looking at the prospect of what is, for most people, their most important investment and asset underperforming expectations, which will negatively affect the net worth of most of us in real terms. The ramifications that this will have on the entire economy are impossible to calculate, but we can be certain that the net impact will be significant and extremely negative.

This could be the final nail in the coffin of the American middle class, which has been struggling in the past few decades already. The middle class will most likely be the most affected by this, given that middle class house prices will most likely perform the worst. I think this is likely to be the case because lower cost houses will most likely hold up alright as younger people will look for affordability, while professional elites and others in the upper middle class, who hold up the higher end of the housing market, should continue to do alright in terms of income as well. If the middle class starts to feel more and more impoverished, due not only to the real value of their houses eroding, but also due to all other challenges such as increased student loan debt, eroding income potential due to under-employment, lack of job security, and other issues, we could see stagnation in the economy's most important engine, namely consumer demand, which makes up almost 70% of GDP.

When most people talk about another housing crisis, they assume that the danger lies in a repeat of what happened in 2008. The problem we are facing right now is one that is of an entirely different nature. It is a problem of house prices outstripping the growth in median household incomes by a wide margin in the past few decades, which was achieved in large part with the help of interest rates seeing a steady decline since the early 1980s. We recently hit the bottom of what is feasible in regards to interest rate effects in my view;b therefore, we will now see a reversal in the trend of the growing gap between median household incomes and median house prices. The more than five to one ratio is likely to retreat back to somewhere below four to one gradually, leaving most people feeling like they are worse off. The trend already started last year in my view and it will most likely continue as a long-term decades-long trend. Where this leaves the US economy is hard to say. I personally think that it is in the position of having to cope with a decades-long outlook of worsening consumer mood, and all that is associated with it. It is yet another indicator suggesting we are in for decades of economic stagnation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.