The housing market will not repeat its previous patterns over the last 45 years. Using underwriting standards and looking at the inflation adjusted cost of money, we are in a new era in which the eras from 1965 to 2008 are not comparable.

From 1965 to 1982 there was a lot of inflation and it kept increasing until 1982 when the Fed tightened the money supply with Prime rate at 22%. During this era the real rate (inflation adjusted rate) of interest was sometimes negative so that borrowers were willing to borrow to buy a house even if the rate was 12%.

Then a new era of low and declining inflation started in July, 1982 when the Fed’s tightening was so radical that it ended inflation and thus made interest rates come down to reasonable levels. In 1984 the first “Easy Qualifier” home loans started becoming available. These allowed borrowers to get a loan without proper income documentation which led to abusive behavior by some borrowers and excessive, unaffordable borrowing which led to a housing bubble. Also at this time the Shadow Banking industry of non-bank lenders began to offer loans using securitized lending. These acts set the stage for a massive housing bubble that lasted until the crash of 2007-2008 at which time a new era in housing has started.

Now Easy Qualifier (no income verification) loans are outlawed and loan securitization by non-bank lenders has been greatly reduced. So the new era has much harder rules that greatly restrict how much consumers can borrow. Since most homes are financed with a mortgage then this reduction in mortgage lending means that consumers will simply have to buy a lower priced home than what they were used to. So this will put downward pressure on home prices. Basically in a normal lending environment (that did not exist during the time of Easy Qualifiers) what drives mortgage approvals is personal income, not interest rates. So housing could only go up in proportion to the average person’s personal income which grows slowly and steadily, so this why before the Great Bubble of 1983-2008, nationwide home prices did not go up faster than inflation, after adjusting for quality.

The era of inflation for 1965-1982 was an era of cheap money on an inflation adjusted basis, which explains appreciation then. It was an era when people tried to protect themselves from inflation by buying real estate. The era from 1982-2008 was a credit bubble era where loans were granted increasingly with less restriction each year so that in the final years of the bubble the loan underwriting rules were a meaningless joke for those willing to pay the fees charged for “Easy Qualifiers”. During 2001-2006 it was possible to buy a $1,000,000 house with no down payment and no verification of income and no lender’s recourse if the borrower decided to go into foreclosure! No wonder prices appreciated excessively. My point is that financing and inflation conditions since 1965 until 2008 were an unusual situation that won’t be repeated and thus one can’t use the data of the past 45 years to look for patterns that would indicate if another housing boom will start. The best forecast should be based on the fact that mortgage lending is tied to income and income will be growing very close to zero on an inflation adjusted basis. Also there is a huge overhang of shadow inventory that will produce a surplus of housing inventory until 2017-2018. Also, baby boomers need to downsize their homes to free up equity. Also personal incomes will be stagnant or slow growing for a long time, and what little growth of incomes occurs will need to be spent on rising medical costs. As a rule of thumb, when a bubble is busted it remains busted and new bubbles form elsewhere. Remember the Tech stock crash of 2000 and how long those stocks stayed down at low prices. The NASDAQ is still about half of its high water mark of 11 years ago.

This type of blog post is an example of independent investment advice.