How Much Longer Can Our Unaffordable Housing Prices Last?

Markets discover price via supply and demand: Big demand + limited supply = rising prices. Abundant supply + sagging demand = declining prices.

Eventually, prices rise to a level that is unaffordable to the majority of potential buyers, with demand coming only from the wealthy. That’s the story of housing in New York City, the San Francisco Bay Area and other desirable locales that are currently magnets for global capital.

In the normal cycle of supply and demand, new more affordable housing would be built, and prices would decline.

But that isn’t happening in hot real estate markets in the U.S.  What’s happening is rental housing is being built to profit from rising rents and luxury housing is being built to meet the demand from wealthy overseas buyers.

With limited land in desirable urban zones and high development fees, it’s not possible to build affordable housing unless the government subsidizes the costs.

Meanwhile, the supply of existing homes for sale is limited by the owners’ recognition that they won’t be able to replace their own home as prices soar; it makes financial sense to stay put rather than sell and try to move up.

Some homeowners are cashing in their high-priced homes and retiring to cheaper regions. But this supply is being overwhelmed by a flood of offshore cash seeking real estate in the U.S.

This is part of the global capital flows I described in my recent analysis What Happens Next Will Be Determined By One Thing: Capital Flows. As China and the emerging market economies stagnate, capital that was invested in these markets in the boom years is moving into dollar-denominated assets such as bonds and houses.

This globalization of regional housing markets is pricing the middle class out of housing in areas that also happen to be strong job markets.

Many commentators are concerned that a nation of homeowners is being transformed into a nation of renters, as housing is snapped up by hedge funds and wealthy elites fleeing China and the emerging markets.

But will current conditions continue unchanged going forward?

Let's start with the basics of demographic demand for housing and the price of housing.

Demographics & Housing Valuations

There are plenty of young people who'd like to buy a house and start a family (a.k.a. new household formation), but few have the job or income to buy a house at today's nosebleed levels -- a level just slightly less insane than the prices at the top of Housing Bubble #1:

(Charts courtesy of Market Daily Briefing)

The current Housing Bubble #2 (also known as the Echo Bubble) certainly isn’t being driven by rising household income, as median household income has declined when adjusted for inflation:


What enabled households to buy homes as prices pushed higher?  Super-low mortgage rates:

Now that mortgage rates have hit bottom, there’s not much room left to push housing valuations higher by lowering rates. No matter how solid the buyers’ credit rating, mortgages remain intrinsically risky, as unexpected medical emergencies, job losses, divorces, etc., trigger defaults in the best of times. In recessions, job losses typically cause defaults and lenders’ losses to rise.

All debt, including home mortgages, is based on household income and debt levels. The higher the debt load, the more money the household must devote to debt service. That leaves less to spend on additional debt or other spending.

As this chart shows, the ratio of debt-to-earned income (wages and salaries) has declined since the speculative frenzy of Housing Bubble # 1, but it remains almost twice the levels of the pre-bubble era:

Based on the fundamentals of domestic income -- debt levels and current home prices -- only the top 10% of households has much hope of owning a home in globally desirable regions:

If domestic buyers can no longer afford to buy, then who’s left? Cash buyers from overseas is one answer.

Capital Flows into U.S. Real Estate

Chinese millionaires buying homes for cash in the U.S. and Canada have been voting on conditions in China with their feet.  The tide of money leaving China has turned into a veritable flood, with hundreds of billions of dollars leaving China in the past year aone as economic conditions there deteriorated.

This flood tide can be seen in real estate transactions, not just in the U.S. but in Australia, Canada and the U.K.:


These cash purchases by wealthy foreign nationals are creating a bifurcated housing market. In areas deemed desirable, Chinese and other foreign nationals are dominating the market (see: 80% Of All New Home Buyers in Irvine, CA Are Chinese).

In regions that are below the radar of offshore buyers, for example, broad swaths of the Midwest, home prices remain more affordable.

But even domestic markets with relatively few foreign buyers have seen soaring home prices if there is strong job growth and limited land for new development.

A Bifurcated Housing Market: The New Normal?

These dynamics have created islands of strong job growth and global/domestic demand for housing in which only the wealthy can afford to buy and everyone else is a renter for life. These islands are surrounded by a sea of lower-cost housing in regions with weak job growth and stagnant wages.

Is this bifurcation the New Normal? Or is Housing Bubble #2 heading for the same shoals that popped housing bubble #1 in 2007-08?

Right now, the general consensus is that housing prices “will never decline” in New York City, the San Francisco Bay Area, etc.—the islands of job growth and high valuations--due to the strong U.S. economy and capital flows into USD-denominated assets. But if the bulk of this capital flow has already occurred, and capital controls and clawbacks become the order of the day, this prop under current nosebleed housing valuations might be kicked away far sooner than anticipated.

In Part 2: How A Major Housing Correction Can Happen Over The Next 1.5 Years we examine the strong argument can be made that conditions are far more fragile in this Bubble #2, as the global recession that is rapidly spreading around the globe can’t be reversed with the same bag of tricks that worked in 2008-09.I expect home valuations to fall rather quickly once capital flows out of China drop off and the recession swamps America’s economy.

History suggests that the markets that soared the most are also the ones that collapse the farthest.

Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

This is a companion discussion topic for the original entry at

Aloha! Many mahalos Charles! Seems to follow what the Japanese did with US real estate in the 1980s, especially in California.

Here in Hawaii when the Japanese GDP went bust a lot of Japanese banks owned Hawaii property with huge losses, some as much as 80%. I went shopping for real estate in Kailua-Kona after the US Tech crash in 2001 and realtors showed me a lot of property still owned by Japanese banks. The idea that property bubbles unwind quickly is a farce. From 1985 to 2015 is a long time. A lot of those Japanese bank execs who wrote those Hawaii loans in 1985 are no longer alive. Their irresponsibility has cost the next generation tremendous pain, but I am sure that was not an issue or even a minor consideration in 1985.


As the chart shows above now it is the Chinese banks turn to make the same mistakes the Japanese made in the 1980s. You can't mouse click real estate deals as many Japanese found out the hard way. The problem with owning foreign real estate is you can't take it with you! On the other hand who in China wants to hang around for the next Mao! A warm beach in Laguna is a better retirement choice than making mud bricks at the Laogai labor camps!

Is it really a boom yet? Timing is everything especially in real estate, but judging by the above chart from the Chinese real estate site Juwai I would say we're at record highs at the least. Human condition drives our emotional choices to buy or sell and not even I-Pads change that. Nothings changed in the human condition since the first caveman invented fire … the first "killer app"!

Hi Kaimu: thank you for the great charts and insightful commentary. You are so right about the Japanese banks in Hawaii still hiding losses decades later. To some degree this is the result of the Japanese authorities allowing banks to hide their losses, i.e. become Zombie banks with inflated assets that can sit on their books for years or decades. If those assets were marked to market, the banks would be revealed as insolvent.
There is also an element of "face" in all this. It is humiliating to publicly absorb huge losses and go BK, so the Japanese chose the zombie-bank route, which has cost them 25 years of stagnation.

They also overpaid for art, some of which was sold very quietly in the 1990s for a fraction of the 1989 price. Will the Chinese also choose the zombie route rather than absorb their losses? It's an open question.


CHarles, I have an off-topic question: how could I get one of those FRED charts like the one in the article, but with a timeline of 100 years or so?
I ask because I saw one a few years back, and out of curiosity counted the shaded bars.  My memory is that there were 20, i.e., an average of one US recession/depression every 5 years (the standard deviation would be high, but still…).  I'd like to confirm what I remember.
Basically, that seems to say that our economic system has always relied on bubbles to achieve long-term growth, each bubble rising higher than the preceding bust declined.

Sudden thought: it'd be interesting to add "war years" to the graph, i.e., years when US troops were engaged in military action somewhere around the globe.

Dwig, those are very good ideas to chart.  Our charting maven here at is davefairtex–perhaps he has a source.  I usually just type in the name of the series I'm looking in google and then choose the image tab to scroll through whatever charts google turns up.
The FRED data is not uniform. Some series only go back a few decades.

As for overlaying the years of US forces in combat zones–I suspect it would show a major increase in the post-WW2 years, which really kicked off the imperial age.  It's practically an unbroken line since 1991/Gulf War 1.


Google search came through:  They have data back to 12/1854.  Looking at 1/1/1900 - today, I get 23 (some of those are pretty close together, and maybe should be merged.)
I'll be interested to see if davefairtex weighs in on this…

Nice work, Dwig–the only wide recession-free bands were 1) WW2, 2) the 1980s boom 3) the dot-com boom.

Charles, remember the $7,500 tax credits for first time home buyers (2008, 2009, 2010)?  That money certainly goosed the all but dead housing market.  Now imagine that the USG could get even more creative and decides to subsidize buyers in another way, like buying down the GSE's mortgage rates to 2%, and coupling that with 40 year mortgage amortizations.  Payments would be lower than rents, even in many areas where there are jobs.  The Fed could then buy those GSEs, through the FRBNY's primary dealers, and, ultimately, retire them in much the way it retired the toxic CMBS in Maiden Lane 1, and the NPL GSEs it "bought" from the big six banks.  
Without an audit, it's not easy to track the Fed's "assets" or its money printing.  The last audits, the Paul/Sanders and Bloomberg audits (2008-2010), revealed to us that the Fed made $23.8 trillion available to the international banks, so that many of them could buy back their TARP debts.  This time, the Fed could print money, in amounts that would never be revealed to the public, and funnel it to other central banks, so that they could soak up those newly minted GSEs.

Chris, my daughter was a Duke geology major, like you, then got her MS in geology at the University of Wisconsin Madison, and, because of the commodities crash, is going back to school to learn coding.  When it comes to employment, our young will have to be fleet of foot and adaptable.  

Rich, what you sketch out is certainly plausible.  There are couple of wild cards, though. One is property taxes, which was mentioned by another reader in the thread on Part 2. States such as Calif. have Prop 13 limits (though increases can be added by voters' approving school bonds,  filling-potholes bonds, etc.). But many states have no such limits, and counties can jack up property taxes even if property values are declining.
Another wild card is related to your point about employment nowadays being insecure and the need for flexibility.  Buying a house still involves commissions, etc., and it isn't as easy to move as when you rent. If the market turns down, selling can become a long, drawn-out process.

"Jingle mailing" the keys to the lender is one quick way out, but that also damages your credit.

Renters don't have to worry about repairs. Owners do. The cost of ownership simply isn't as predictable as rent. Poorly built or old houses often generate mega-costly repairs.

My point is that buying is much more complicated and burdensome than renting.

There is a certain set of conditions that enable people to buy homes, and price/monthly payments is only one. I wonder if everyone who wanted to buy and could buy has already bought. Who is left but the highest risk, lowest credit rating, most insecure borrowers?

Lowering interest rates further may be a case of diminishing returns.

So I found the recession timeseries (it is the tag USREC followed by many different extensions) and I can now apply it to any timeseries you like.  Which one did you want?  The Case Shiller Home price series only goes back to 1988.  Was there another series from a different place you wanted?


Charles, I'm not arguing the fact that there are many reasons to choose renting over owning, and one of those, which you did not list, is that a whole generation of potential home buyers is burdened with over a trillion dollars in student loan debt.  However, there is little to stop the government from forgiving some of that debt, and converting those potential buyers into actual buyers.  Still, the American Dream, whether real or imagined, is for Americans to own their dream homes, and, if a large percentage of Americans can believe in Donald Trump, an even larger percentage can believe that it will someday own that dream home (regardless of how impractical home ownership might or might not be).
I own my own home.  In fact, I own many homes, some which I have built for myself.  I rent these homes out, because I have no other access to any other predictable ROI.  Many of the homes bought in this country, last year, were bought for the purpose of producing rental income.  What's been lagging are those first time home buyers that push the move-up home buying market.  All I'm saying is, that if the government makes it easier for first time buyers to buy, they will buy, in spite of the logical reasons you have stated for not buying. Think about it, Charles, is there any financially logical reason for someone to get a subprime, 8 year auto loan, for a loaded up, new truck or SUV, that they can do without?  It's because of financialization that Ford is selling the hell out of $50,000 pickups, that ten years ago were $25,000 pickups.

Other things you don't seem to consider are appreciation and location.   As this country becomes more chaotic, elite dwellings in gated communities will increase in value.  Then there is the USD.  Over the long term, as the dollar loses value, home prices, in the right locations, will gain value.  My father bought our first family house in 1951.  It was as small 3/1 for which he paid $17,000, new.  It is in Silver Spring, Md, and sold last year for $565,000.  In other words, in the time it took the dollar to lose 90% of its value, that little house sold for 3300% more than it did 64 years ago.  In the silicon valley, the difference would be far greater.  In Detroit, however, that same house is probably worth less now than it was worth 64 years ago.  All I am saying is that one can't accurately paint the housing situation with one broad brush.  Consequently, predicting the future of American housing, pretty much has to be done on a local level.

In cases of inflation, house prices generally go up.  In cases of hyperinflation, food prices go up far more than houses prices do.  Home values and rents suffer in periods of hyperinflation.  However, hyperinflation is rare, and inflation is common. 

Rich, I agree with you about home values rising, I am just wondering if the wage/price/debt structure allows for a buying boom that will absorb new construction and homes sold by boomers. In hot job markets, certainly; elsewhere, as you say, we get Detroit. I suppose what I'm questioning is the foundation of home-buying (wages) and the culture of home buying. Are Millennials as keen on home owning as their elders? Probably, but perhaps the jury is still out. 
Forgiving student loan debt once the debtor buys a house/gets a mortgage would be an innovative debt swap…

Charles, renting is also problematic.  Many in the US are already paying over 50% of their income for rent. In Berlin, Germany, where over 60% of the people rent, rents gobble up over 65% of their net incomes for the average 3bdr apartments.  It's been that way for years.  
The question I asked NAR's chief economist last week, when he was painting a rosy scenario for higher rents, was how can rents continue to rise when we have the highest number of working age people out of the workforce in 37 years, when a large percentage of those jobs being created are part-time jobs, when wages have been flat, at best, for at least ten years, and when automation is gobbling up jobs faster than jobs can be created.  His reply to that room of 150 commercial realtors, local politicians and developers was, "That's too deep to discuss here and now".  Still, Berlin shows us that people will pay what they are forced to pay, unless they start doubling up and creating vacancies in the rental market.

As for baby boomers, there is a major home healthcare/aging-in-place movement going on nationwide:

"Today’s seniors are living longer and are frailer than those of past generations, requiring added assistance. Most elders would prefer to receive help where they live, rather than make a move."



Ok, so I can't compete with you in terms of access.  The NAR cheerleader would just give me the fish eye if I had the temerity to ask him a question.

Fundamentally, US home prices are underpinned by four decades of debt growth.  Debt growth is where asset inflation comes from, as well as consumer inflation.

Therefore, if we go into debt deflation in any meaningful way, housing prices will plummet.  As we know, the price on 50 houses are set by the sale of the one in the neighborhood that sold for whatever reason.

See, housing may be local, but the debt deflation effects have the ability to completely swamp most local factors if they get severe enough.

Of course, if we get inflation - and the only way we get inflation is if we get that great blob of debt growing again - then things will continue rising as they have for the past 40 years.

Long term, I believe housing's fate is less about the Chinese, and a lot more about whether or not we have continued debt growth.

Once you take the Chinese out of the equation, with no aggregate debt growth, you have no house price appreciation - unless you get cash from a hedge fund flowing into the sector because they are desperately chasing yield.

Of course if you have a house near a "sure thing income source that will never be cut" (i.e. some sacred cow government institution) then you might be insulated, but otherwise - housing prices are all about debt.

Again, my perspective is all the big picture macro view.  I'm sure your specific collection of houses are in fantastic locations that could never go down, ever.  :slight_smile:

Housing prices are also about interest rates. People (most) don't buy a price, they buy a payment.
Rising interest rates (surely they will rise at some point) are likely to stifle debt growth and will KILL home prices. The fallout in local government's revenues, in my opinion, will be devastating.

Dave, it's actually far simpler than that.  Without government-backed mortgages (Fannie/Freddie, FHA, VA, FDA and USDA) there would be nothing to prop up house sales.  I'm old enough to remember when getting a conventional mortgage meant getting a privatly backed mortgage or a bank owned mortgage.  Today, only a very tiny percentage of mortgages  (jumbo mortgages for the ultra-rich) are not backed or insured by the Federal Government.  On top of that, the Federal Government gives borrowers tax deductions on the mortgage interest they pay.  So far, there have been almost no limits on far the government will go to prop up house sales. However, if the Republicans took power of all three branches of government, and they actually made good on their promises to re-privatize Fannie and Freddie, US house sales would pretty much collapse.  Price deflation, at that point, would be pretty much universal. 

So far, there have been almost no limits on far the government will go to prop up house sales
But why prop Up house prices?   Because they must.   Plutocrats have the most to lose and the least to gain from rebellion.  The biggest pacifier of the population is middle class debt. The greater the percentage shackled with imagined debt that they are convinced has to be paid back the more stable the society.   The Plutocrats aren't thick.  They have read Niccolò Machiavelli too.

But, Oh dear! What is happening?   The middle class has been destroyed. 

Here is an interesting graph. It shows the worsening gini coeficient and political instability. Does that look about right to you?


Arthur, great chart, thanks for posting.  It gets right to the heart of the real agenda for propping up housing by whatever means are necessary:
As earned income has stagnated for secular reasons (automation, rising debt service, stagnating productivity gains, advantages of capital over labor, globalization/ wage arbitrage, etc. etc.), the Status Quo has attempted to compensate for this decline in middle class earned income with gains in unearned income/wealth via asset inflation–housing being a major component of middle class wealth, and stocks/bonds to a lesser degree.

Unfortunately for the Powers That Be, their mechanisms for boosting asset prices (with the goal of generating 'the wealth effect" in the stagnating middle class) also generate bubbles and rising legacy debt Davefairtex described. the boom/bust cycles actually reduce middle class wealth as people buy at the top (or buy more at the top) and then see their paper wealth plummet in the next crash.

This has made many middle class people either 1) too cash-poor to save money to gamble in stocks or 2) wary of investing in stocks. That leaves housing as the only possible "fix" for stagnating middle class income/wealth.

We all know how housing boosts income–via HELOCs (home equity lines of credit), cash-outs followed by a move to a lower-cost region, reverse mortgages, etc.

If housing tanks, the last prop under the veneer of middle class wealth collapses. No wonder the Powers That Be are so desperate to prop up housing. But IMO the bubbles and busts they've engineered are integral to credit/asset booms; their goal was a smooth increase that never falters but that simply isn't possible.

Rich, you make a good point with Berlin. But let's include two factors in German housing: 1) German housing has not appreciated much in recent decades, as policies were not supportive of housing-based asset bubbles and 2) Berlin is the "hot" place to live, the equivalent of SF or NYC for young people. Not coincidentally, rents are insane in SF and NYC but young people still flock there. Outside of Berlin (for example, Munich), our German friends pay a fraction of the rents in "hot" US markets.

I suppose the question boils down to: can USG policies keep housing prices propped up?  At some point this boils down to: can they change the psychology of potential buyers? I think Rich is suggesting they can do so by making buying cheaper than renting. That would certainly make owning attractive, but the overall cycles of debt expansion and contraction are accompanied by large-scale shifts between risk-on and risk-off behaviors. Even if it's cheaper, buying a house is generally a risk-on decision that's psychologically easy in periods of expansion and less easy in periods of uncertainty, fear, and generalized risk-off.

So we're saying the same thing.  Government-backed mortgages are the government's way to continue injecting debt money into the marketplace.  Likewise tax deductions on mortgage interest.  Government recognizes that without debt at least staying constant, home prices will plummet.  And yet, the home mortgage debt timeseries continues to head lower.

Did Charles do this chart?  I forget.  Gosh I could scroll back but…

Man.  With all those gov't supported 30-year mortgages, and 3.5% mortgage rates, households are still deleveraging.  And remember, this chart is in nominal terms.  If we adjust for inflation, the deleveraging looks much stronger.  My assessment: there is zero chance either party will shut down fannie/freddie, or get rid of the mortgage interest deduction.

Going back to Rich's comment #10 above about Rent vs Own.  Is there any information showing how much the rent market is propped up by the 1937 Section 8 program? Last I saw this was for over 2 million rental households…   If this is eliminated in the future due to default or whatever, this lack of injection of government money into the rental market would cause rents to fall.