Those words, uttered by President George H. W. Bush in 1992, may be a harbinger of things to come, if the most recent home price data is any indication. After more than a year of widespread bubble-like increases in home prices across the U.S., the June data revealed the first cracks in the housing bubble. Driven by a combination of affordability challenges brought on by the significant run-up in prices, and a 275 basis point (bp) increase in the average 30-year fixed mortgage rate in just six months, the nascent turn in home prices could signal a shift in the direction of overall economic activity.
It makes sense that housing would be a significant driver of the direction of the broader economy; demand for housing drives demand for a range of other consumer goods, particularly big-ticket items that comprise a fairly large portion of retail spending. As housing activity declines, that spending tends to grind to a halt, bringing overall consumer spending down with it.
Against that backdrop, let’s look at the recent data. There are two primary home price indices, the FHFA House Price Index published by the Federal Housing Finance Agency, and the S&P/Case-Shiller (SPCS) Home Price Index. The FHFA Index is available for virtually all markets in the U.S., from Bakersfield to Burlington to Birmingham, while the SPCS series is only available for 20 major markets. Another key difference – and this is of particular importance for purposes of this article – is that the FHFA series is quarterly, while the SPCS data is monthly.
Both series were released for June (for Q2 in the case of the FHFA data) on August 30, and the two sets of data painted somewhat different pictures. (We’ll explore why a bit later.) The FHFA index covers some of the hottest markets in the U.S, such as Reno, Boise, and Austin. Recent anecdotal data tells us that those markets are slowing down fast: they lead the nation in listing price reductions and contract cancellations, and inventories there are rising rapidly. Let’s look at the Q2 price data to see whether it corroborates the anecdotal evidence.
- Home prices in the Reno Metropolitan Statistical Area (MSA) in Q2 were up 6.8% from Q1. Year over year, prices were up 22.3% in Q2, a bit lower than the last three quarters, but still a sharp increase.
- In the Boise MSA, home prices were up 7.6% in Q2. Year over year, prices were up 22.1% in Q2, less than in the previous four quarters, but again, more than a 20% increase.
- And in the Austin MSA, prices were up 10% in Q2. They were up an eye-opening 31.4% year over year – again, lower than the previous three quarters’ rate, but still quite high.
- Looking at the FHFA index for the U.S., it was up 6.8% in Q2. Year over year, it was up 20.9% – not only higher than in any of the previous four quarters, but also the highest year over year increase on record.
Now, let’s turn our attention to the SPCS data. The bellwether 20-city composite index increased 0.4% in June, vs. a 1.2% increase in May and a 1.7% increase in April. Year over year, it was up 18.7% in June, the lowest annual rate of increase since December. From August 2020 through April 2022, all 20 markets in the composite index posted monthly gains, the longest stretch on record. In May, only 19 markets posted gains, and in June, only 13 markets reported gains – the fewest since March 2019.
All but two of the 20 markets were down year over year in June, and of the two that weren’t, one was flat. Seven markets posted outright monthly declines in home prices in June: Los Angeles, San Diego, San Francisco, Denver, Washington D.C., Portland, and Seattle. All but one of the remaining markets posted smaller increases than in May.
This explains part of the reason for the divergence between the FHFA data for Q2 and the SPCS data. Let’s look at the SPCS market that posted the largest monthly price decline for June, Seattle. In June, prices there were down 1.5%. In May, the SPCS index for Seattle was unchanged from April, and in April, it was up 1.1% from March. The June index level was 398.15; the March reading was 400.11. Thus, for the quarter, prices in Seattle rose, but that was due to an increase in April and virtually no change in May. For the month of June, prices were down. That explains the fact that the quarterly FHFA index for Seattle showed an increase, while the more timely monthly SPCS data for June reveals emerging price weakness.
(The other explanation for differences between the two indices is the different methodologies used in calculating them. Without delving into those methodologies, the SPCS is considered to be the more robust of the two measures, and is preferred for markets for which it’s available.)
We see the June SPCS as the tipping point for the U.S. housing market. The July data will likely bring declines in more markets in the index, and the Q3 FHFA data will show broader declines. This is corroborated by other recent housing data: single-family housing starts and building permits are down sharply; home sales have been declining since the first of the year (new home sales in July were at their lowest level since 2016); and inventories are rising sharply (the monthly supply of new homes is the highest since March 2009, as speculative building resumed over the last year).
We do not foresee the kind of fallout from this correction that we witnessed in 2008-09, however. Buyers who’ve paid premium prices in this bubble did so with more skin in the game, so we’re not likely to see the kind of negative equity we saw in the 2000s. Subprime lending is all but non-existent today, so the knock-on effects of any increase in charge-offs will be far less severe. The fact that there is less securitization of subprime debt will also limit the contagion from this bubble bursting.
Still, lenders should prepare for prices to go still lower, because mortgage rates could well go still higher. Recent policy decisions coming out of Washington point to continued high inflation, and recent comments made by Fed officials indicate that the monetary policy response will be continued firming, with no expected easing in 2023, in spite of a softening economy. And while 30-year fixed mortgage rates have come off their highs, the most recent trend as of this writing is upward, with rates climbing 67 bp in the last month.
All of this points to a call for caution in underwriting. Be sure to adhere to GSE standards, and focus on purchase mortgages to the extent demand still allows (which should be easy, as refinances have already dried up). Home equity demand has been strong for many credit unions, but be very careful in looking at combined LTVs, with preference toward borrowers where the credit union holds the first lien, because in addition to the risk of a negative net equity position, there’s the effect of rising rates on variable-rate products, and the fact that there’s a good chance that a recession is looming on top of the housing correction.