The combined worth of the U.S. housing market is $26 trillion and climbing, according to the Economist. This is more than the all the money in today’s U.S. stock market, and investors are watching this very heavy asset class closely for signs of danger.
What sort of danger, you ask?
From a big picture perspective, the main risk lies in the slippery hands of the bond market.
Individual mortgages are bundled together into mortgage backed bonds (MBBs), which are sold on the bond market in the U.S. and globally. The Economist estimates investors currently hold $7 trillion of these MBBs.
This same intricate web of investment was a big part of why, when the housing market stumbled in 2006, the global economy collapsed around it in the years following. Investors had too much at stake in a risky system.
But surely, having learned from our mistakes, all the new regulation since the financial crisis has diminished the economic risks of the housing market!
According to the Economist, that sort of thinking is “wildly optimistic.”
That’s because, in an attempt to soothe investors back into making investments, the U.S. government has provided more guarantees on mortgages. While this alleviates the investor risk and encourages investment in housing, it puts the risk squarely on taxpayers. Along with mortgage subsidies like the mortgage interest deduction (MID) equal to $150 billion in lost revenue each year, taxpayers are on the hook for housing now and — in the event of another housing crisis and bailout — even more in the future.
Further, the housing market is not as stable as it looks from far away. Look closer, and the cracks are showing.
Cracks in the foundation
True, home prices are rising here in California and across the nation. In most high-tier home markets, home values have finally surpassed pre-recession heights (though it took a decade to do so). Meanwhile, low- and mid-tier home values continue to increase and homeowners gradually shed their negative equity status, now able to move and meaningfully contribute to the economy.
However, the price rise lacks the necessary support of:
- home sales volume, which has bumped along at relatively the same low levels since 2009; and
- homebuyer incomes, which are rising gradually, but at a pace far below that of even the most modest home price increases of 2016.
Together, these stumbling blocks show real demand from homebuyers is still lacking in today’s market. Sure, potential homebuyers are interested in buying, but they are unable to qualify at today’s prices, which continue to increase due to a lack of supply in desirable cities and neighborhoods. Once significant change takes place — like a supply increase or higher incomes — active demand will be evidenced in rising sales volume, which will give prices the long-term support needed for stability.
When you build a structure tall and don’t take the time to build a strong base, it is liable to fall at the first sign of trouble.
Given this information, are we glimpsing another housing crisis on the horizon?
Not just yet. Yes, as the Economist points out, there is plenty of risk inherent in our nation’s housing market — specifically in mortgages and the “free (never-ending) lunch” the government is handing out to lenders, on the taxpayers’ tab. As we move further away from the financial crisis, it may be safer for the long-term stability of the housing market if the government weaned the market off subsidies and blanket guarantees. Returning the lending risks from taxpayers back onto banks will also perpetuate safer lending habits, lessening the potential for another crisis.
But the good news is stricter lending regulations fell into place following the 2008 Great Recession, codified in the Dodd-Frank Wall Street Reform and Consumer Protection Act. Therefore, the mortgages bundled and sold on the bond market are — in theory — less dangerous to investors (and therefore to taxpayers), dampening the risk of a coming collapse.
Further, housing trends are pointing toward improvement, as buyer incomes continue to rise more quickly and home prices increase more gradually. This points to a more stable housing market in 2017 and the years to come.
In the meantime, a watchful regulatory eye is needed on investors in the bond market. After all, it’s everyone else who will pay if corners are cut and the scale is tipped from mortgages being a “safe investment” to downright dangerous.