Housing crisis as incomes do not catch up with home prices

[Andrey Rudenko]

Housing prices, like prices of anything else are driven by the overall supply and demand. The supply is driven by the available inventory while the demand has many input factors in it. Here we will try to see what may happen in the future of housing prices by comparing the historical relationship between the case schiller housing index and personal annual income per capita (both on log 10 scale).

In 1933 during the depth of the Great Depression, both incomes and the housing index saw a massive simultaneous drop. The recovery for housing and incomes, however, was different. From 1933 to 1937, the incomes recovered at a much faster rate than housing prices. In 1938, the incomes declined again while the housing prices remained mostly flat until a drop in 1941 due to massive liquidity shortage. From 1938 until 1943, the incomes experienced another parabolic growth, while the housing price growth was delayed until 1942. After 1942, the housing prices recovered at the same rate as incomes recovered 4 years earlier showing a 4 year delay in housing recovery. The other factors that contributed to housing price growth from 1942 until 1947 are low mortgage rates, increasing M2 money supply and new low down payment loan options: FHA, FNMA and VA loans. In 1949 incomes saw a small decrease again followed by a rapid recovery in 1950. 3 years after, in 1953 the housing prices mimicked the income recovery, showing a delayed effect of income growth on housing price yet again. In 1954-1956, similar delayed effect is seen again, however, on much smaller scale. Such delay could be attributed to people saving more money for a few years and going house shopping once the down payment is saved up.

In summary, from 1930 to 1960, the housing prices had a delayed correlation with incomes, but were also driven by other factors such as, low down payment loan options, low interest rates and liquidity in the capital markets. In the next 30 years, this situation would change a lot.

From 1960 to 1990, the incomes grew steadily, without any appreciable pullback despite several recessions in 1960, 1970, 1974, 1980 and 1981. Such growth was primarily due to rising inflation. During this time, the housing prices generally mimicked income growth, however, without noticeable "delayed" effect that was seen in 1930-1960. The main driver or housing price growth in 1960-1990 was incomes growth, the M2 money creation (the greater liquidity in capital markets) and the new loan options: Freddie Mac and ARM loans in 1980, but not the interest rates that skyrocketed by 1980s.

The same trend continued until 2009, when the impact of the 2008 GFC was so strong that despite relatively low interest rates and continued M2 money creation, the incomes dropped following by the housing price bottoming in 2011-2012 (2-3 years later). After 2009, the incomes began steady recovery again, that helped housing prices recovery 2-3 years later, showing the delayed effect that was previously seen only in 1930s and 1940s. From 2009 onward, the housing prices were driven by income growth as well as historically low interest rates and massive money printing, but not by new loan options as lending became much more restricted after the Dodd Frank Act of 2010.

In 2020 massive changes took place that fueled housing price growth yet again: the supply was restricted as sellers became less comfortable going through traditional selling process and material and labor availability dried up, and the demand increased due to massive stimulus programs, M2 money creation and another drop in the interest rates. Now in 2022, we are seeing the effects of this supply/demand imbalance as housing price growth vastly outpaces income growth, creating a severe housing shortage. Going forward, we do expect the mortgage rates to rise in the next 1-2 years, the stimulus effect (savings) to dry up over time (especially given massive current inflation that shows no signs of slowing down), and the pace of money creation to slow down as well from both the commercial bank lending and also from Fed debt monetization (at least that is what Fed is saying – what they will be actually doing is a different question). These factors will lead to demand decrease. This does not necessarily mean a slowdown in home price growth as it is currently unclear what will happen on the supply side (existing inventory and labor + materials shortages + building and zoning regulation). In a free market, it is much easier to make a bet on growth or decline of a given asset (as long as all variables are taken into account). However, the US housing is far from being a free market. Historically, the biggest unknown has been government intervention – when and what they will do.