How will mood be impacted for the next decade because of the real estate bubble bursting? Lessons from the Great Depression Part 35. The changing psychology on American housing.
Purchasing a home is a highly economic but also gut-wrenching emotional decision. A large number of new home buyers are couples seeking to establish their roots for their family. The biological clock keeps ticking in normal markets but also through manic bubbles. The desire to buy has not been removed from the current market but the psychology surrounding American real estate has definitely been shattered. It is no longer sufficient to have the desire to buy. The household income figures need to work out as well in today’s market. Some are also competing with eager investors that typically do not have the emotional attachment to housing and approach a purchase on a colder and aloof manner. Housing prices in many markets still resemble the bubble markets of a few years ago because those couples still looking to start their families have waited long enough (in their own opinion) and “need” to purchase now. This segment of the population has shrunk in tandem with the economy. Yet this change in mood is nothing new and is something akin to the mood that rose up during the Great Depression. The irony of all of this is that this housing crash is deeper and more widespread today than that of the depression era.
This is part 35 in our Lessons from the Great Depression series:
The fastest housing crash ever
Mood is a fickle thing in bubbles. Psychology becomes the biggest driver of price and speculation in any sort of bubble from real estate to tulips. When things do inevitably reverse to the winds of history, prices can move faster than one would expect:
Source: The Economist
Even in the worst year over year real estate decline during the Great Depression, prices fell roughly 10 percent. During this recent crisis home prices fell year over year by roughly 20 percent. Prices have been shattered in most metro markets around the country:
So far this housing correction has seen real estate values plummet by 32 percent from their peak nationwide. This is astonishing and I think few people understand what this does to the powerful housing psyche in the United States. Before this implosion in real estate, it was rare to find anyone that had actually lost money in the long run with real estate. The mantra of “home prices only goes up” was taken as self-evident. Yet the era of the aughts brought on massive mortgage security speculation courtesy of the Wall Street bankers. This transformed an otherwise mundane investment into a speculative casino. This combined with the powerful desire to buy and many people were suckered into the mania.
How bad is this crash and what will it do to mood going forward?
This price decline is far deeper than the Great Depression:
What is fascinating about the real estate market in the early 1920s is that the real estate fervor hit earlier in the decade while stocks bubbled up in the late 1920s. For example markets in Florida boomed prior to the stock market bubble in 1928 and 1929. This housing bubble was the opposite. We had the 1990s technology bubble pushing stocks to the sky, then popping in the early 2000s while real estate started rallying late in the 1990s and throughout the aughts. As the chart highlights above however, in no time in history have prices surged so high with no underlying economic fundamentals. This manic real estate bubble will transform the buying mentality for an entire generation.
This is why even with low interest rates and many homes available to purchase, home sales are still anemic. John Kenneth Galbraith sums it up rather nicely:
“Far more important than the rate of interest and the supply of credit is the mood. Speculation on a large scale requires a pervasive sense of confidence and optimism and conviction that ordinary people were meant to be rich. People must also have faith in the good intentions and even in the benevolence of others, for it is by the agency of others that they will get rich. In 1929 Professor Dice observed: “The common folks believe in their leaders. We no longer look upon the captains of industry as magnified crooks. Have we not heard their voices over the radio? Are we not familiar with their thoughts, ambitions, and ideals as they have expressed them to us almost as a man talks to his friend?” When people are feeling of trust is essential for a boom. When people are cautious, questioning, misanthropic, suspicious, or mean, they are immune to speculative enthusiasm.”
For the above deep change in consumer psychology this is why home sales in the U.S. remain poor. There is definitely more supply than demand at the moment so prices will move lower (this in spite of the even larger hidden supply through shadow inventory). Combine social mood with weak household balance sheets and you get something like this:
New home sales are at their lowest levels since the early 1960s even with a much larger population. How can that be if home prices are going much lower and the Federal Reserve is artificially pushing rates to historical lows? The reason is more psychological as people become more cautious and wakeup one by one that there was a big bubble and con that just occurred in the aughts. At the core of the con was housing but more importantly, the mortgage which was used as a pawn in the game of investment banking profits. Was any of this financial innovation really good for the country? Who really prospered here? I think these are the questions that are being asked more and more. Ordinary people are starting to realize on a larger scale that politicians for the most part are essentially paid legislation writers for these big financial corporations.
The new home sale chart above is really telling. Only a few days ago the 30-year fixed rate mortgage broke into the 3 percent range. Unheard of in our generation so why aren’t new home sales bustling back up? Like Professor Galbraith stated, low interest rates are the least of concerns when psychologically people are more suspicious of speculation. In some parts of California the speculation continues but will end at some point as well. Some will be naïve enough to dive in because of spurious arguments like “this zip code is immune” or “the good schools here” forgetting that those areas had those attributes in the late 1990s before the bubble even took off. Why are home sales so weak with all these perks? Because the mood has shifted from speculative mania to one of caution and deep mistrust. Sadly, the current mistrust is fully justified as the too big to fail have hidden millions of properties deep in their balance sheets.
Changes in this kind of large scale bubbles take at least one generation to workout. Have you noticed colleagues, friends, or family members become more suspicious to the real estate market?