The Housing Market In 2006-2007 And 2018-2019: Similarities & Differences

As can be seen in the graph below, there is an almost uncanny similarity between housing prices at the 2006-2007 peak and current home prices.

(Click on image to enlarge)

The biggest difference is that current home prices are substantially higher. Should we be worried about a repeat scenario - and another six-year decline in home values?

This analysis explores in detail the similarities between 2006-2007 and current home prices, on a national average basis. When we dig beneath the surface, we also find some major differences as well, which means that the next round could be quite different than the last round.

This analysis is part of a series of related analyses, which support a book that is in the process of being written. Some key chapters from the book and an overview of the series are linked here.

Very Low-Interest Rates - Similar But Different

All else being equal, the lower that mortgage rates go - the higher the price that can be paid for a house, without increasing the mortgage payment.

The monthly payment on a $200,000 thirty-year mortgage loan at an 8% rate is $1,468. That same payment at a 4% rate will support a $307,391 mortgage. So, if interest rates drop from 8% to 4%, and the homeowner is borrowing the money to buy the home, that means they can afford to pay a 54% higher price for their home, without increasing their monthly payments (leaving aside down payments, taxes, and insurance, this is just principal and interest payments).

As previously developed in much more detail in Chapters 3 & 7, the Fed slammed interest rates down to fifty year lows in the attempt to contain the damage from the popping of the tech stock bubble and resulting recession in 2001 and the years thereafter - and by doing so, laid the foundation for the real estate stock bubble of the early 2000s. It became easily affordable to pay record-high prices for homes, thanks to those very low rates.

The collapse of that bubble was one of the leading causes of the Financial Crisis of 2008 and the resulting Great Recession. The Fed then responded with zero percent interest rates and massive monetary creation - and the end results were a second round of the highest real estate prices in history, even higher than the first round (in simple dollar terms).

As a potential recession looms - are we likely to see a second round of major and sustained decreases in home prices? There are many factors involved, but because interest rates and affordability have been so important in the past, let's look for some answers by closely comparing what was happening in 2006-2007, with what we have seen in 2018 and the first six months of 2019 (real estate price statistics lag a bit, they are not available in real-time like stock prices or bond prices).

(Click on image to enlarge)

The graph above is one of the Five Graphs series developed in Chapter 3, and it shows Federal Funds rates on an annual average basis. The green and blue areas look at what was normal before the first containment of crisis in 2001, with the green being above average Fed Funds rates, and the blue being below average rates. The gold is the outliers - rates we had not seen until the post-2000 cycles began (or at least not since the 1950s).

As can be seen, Fed Funds rates bottomed out at the outlier of 1.13% (annual average) in 2003. They rose a bit to 1.35% by 2004 and then jumped out of the outlier range and back into the blue area of modern norms with a rate of 3.21% in 2005. In other words, record low rates helped create record high prices, then rates were no longer at record lows - and that created problems for the affordability of those record-high prices.

Home prices peaked in 2006 and mildly declined in 2007. When we isolate those two years above, the average Fed Funds rate had jumped all the way up to 5.0%. This was on the low side for longer-term averages but was back to being in the historical range, and 3.9% above the outlier of a few years before.

When we look at the 2018 to first half of the 2019 period - we see a very different picture. Fed Funds were much lower, and for a much longer period of time. Based on annual averages - Fed Fund rates have continuously been in the outlier range since 2008. And the Fed's 2019 interest rate pivot to forcing rates down in the attempt to prevent recession and crisis (and plunging home prices) is occurring at a place that is a full 3% lower than what we saw in 2006-2007.

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Disclosure: This analysis contains the ideas and opinions of the author. It is a conceptual and educational exploration of financial and general economic principles. As with any ...

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