March 4, 2023 | Housing Bust #2 Has Begun

This is the transcript of my podcast on Sunday, February 26, THE WOLF STREET REPORT.

The housing market in the United States has turned down, and in some big markets very dramatically so. Other markets lag a little behind.

That’s how it went during the last Housing Bust, that I now call Housing Bust #1. During Housing Bust #1, Miami, Phoenix, San Diego, Las Vegas, etc. were a little ahead; other places, like San Francisco were a little behind. In 2007, people in San Francisco thought they would be spared the housing bust they saw unfolding across the country. And then it came to San Francisco with a vengeance.

This time around, San Francisco and Silicon Valley, and the entire San Francisco Bay Area, are at the forefront, along with Boise, Seattle, and some others. In the San Francisco Bay Area, during the first 10 months of this housing bust, Housing Bust #2, the median house price has plunged faster than it did during the first 10 months of Housing Bust #1. That’s what we’re looking at. I’ll get into the details in a moment.

Across the US, home sales have plunged month after month ever since mortgage rates started to rise a year ago. In January, across the US, total home sales plunged by 37% from January last year. Sales plunged in all regions, but they plunged worst in the West, by 42% year-over-year, and the least worst, if I may, in the Midwest, by 33%. This is happening everywhere.

This drop whittled down the year-over-year gain to just 1.3%. At this pace, we will see a year-over-year price decline in February or March, which would be the first year-over-year price decline across the US since Housing Bust 1.

Active listings were up by nearly 70% from a year ago, though by historical standards they’re still low. Lots of sellers are sitting on their vacant properties and are holding them off the market, and are putting them on the rental market or are trying to make a go of it as vacation rentals. And they’re all hoping that “this too shall pass.”

“This too shall pass” – that’s the mortgage rates. The average 30-year fixed mortgage rate went over 7% late last year, then in January, it dropped, went as low as 6%, and the entire industry was breathing a sigh of relief. This was based on fervent hopes that inflation would just vanish, and that the Federal Reserve would cut interest rates soon, and be done with this whole nightmare.

But in early February came the realization that inflation wasn’t just going away. Friday’s inflation data confirmed that inflation is reaccelerating, that it already started the process of reacceleration in December. Some goods prices are down, but inflation in services spiked to a four-decade high. Services is nearly two-thirds of what consumers spend their money on. Inflation is very difficult to dislodge from services. The Federal Reserve is going to have its hands full dealing with this – meaning higher rates for longer.

And mortgage rates jumped again and on Friday were back to about 6.9%, according to the daily measure by Mortgage News Daily. Just a hair below the magic 7%.

And potential sellers are still sitting on their vacant properties, thinking: and this too shall pass.

So how many vacant homes are there? The Census Bureau tracks this. In the fourth quarter last year, there were nearly 15 million vacant housing units – so single-family houses, condos, and rental apartments. That’s over 10% of the total housing stock.

In 2022, the number of total housing units increased by over 1.3 million. If each housing unit is occupied on average by 2.5 people, that’s housing for 3.3 million more people than in the prior year. The US population hasn’t grown nearly that fast in 2022.

Ok, so now here are nearly 15 million vacant housing units. Of them, 11 million were vacant year-round. Some of the 11 million were being remodeled to be rented out, and others were for sale, and that’s the inventory we actually see, and there are other reasons why homes were vacant.

But 6.6 million homes were held off the market, for a variety of reasons, such as that the owners don’t want to sell the property at the moment.

If just 10% of these 6.6 million homes that are held off the market show up on the market, it would double the total number of active listings. If 20% of these homes show up on the market, it would trigger an enormous glut.

This is the shadow inventory. It can emerge at any time. And during Housing Bust 1, this shadow inventory that suddenly emerged created the biggest housing glut ever.

Since the San Francisco Bay Area is ahead of the game, let’s look at it more closely. It’s a market with a population of just under 8 million people. The median price of single-family houses in January plunged by 35% from the crazy peak in April last year. Year-over-year, from January to January, the median price has plunged 17%. This is according to the California Association of Realtors.

In dollar terms, the median price plunged by over half a million bucks from the peak. That’s a lot of money to go up in smoke.

Well, it’s not really money that went up in smoke, it’s the illusion of money that went up in smoke.

Prices had spiked so fast during the free-money era of the pandemic that this massive plunge didn’t even take the price back to January 2020.

Not that many people bought a house during these three years, and fewer still bought a house near the peak. So the plunge in prices didn’t actually impact a lot of homeowners – just those who bought after mid-2020. That’s a relatively small number. The homeowners who bought in 2019 and before, that’s the vast majority of homeowners – they are still above water, and many of them are still sitting on a lot of equity.

But this thing is moving fast now.

During Housing Bust 1, over a two-year period, the median price in the San Francisco Bay Area plunged by 58%. Now, we’re 10 months into housing bust 2.

So over the first ten months of Housing Bust 1 back in 2008, the median price plunged by 21%.

Over the first ten month of Housing Bust 2, in 2022 and 2023, the median price plunged by 35%.

In other words, the median price is now falling faster than it did in 2008.

Granted, median prices are not the most reliable measure. They’re very volatile and they’re seasonal. And they can get skewed by a change in the mix. For example, if the rich pull their homes off the market because they can afford to hang on to them, and only mid- to lower-end homes are sold, then there are fewer high-end homes in the sales mix, which pushes down the median price. This happened during Housing Bust 1, and was a factor in the 58% plunge in the media price.

There are other markets that have home price declines that are similar to those in the Bay Area, including Boise and Seattle. But other markets just started turning down.

In the Bay Area, home sales – so the number of sales that closed – collapsed by 37% year-over-year, which is just above the national average of 34%. This is the sign of a frozen market.

Active listings have jumped in the Bay Area, and days on the market have nearly tripled from a year ago, to 32 days.

Pulling the home off the market is now a common practice. What lots of sellers are now doing is that they list the home at some aspirational price, and no one shows up. A month later, they pull it off the market. A month later, they list it on the rental market to see if they can get someone to fork over enough in rent to cover the mortgage payment. And that obviously doesn’t work. So then a month later, they pull it off the rental market. And then another month later, they relist it for sale at a lower price. Others are trying to make a go of it as a vacation rental, but there are tons of vacation rentals all over the place, and it’s hard to make that work.

If sellers cut the price enough, eventually the home will sell. If the price is right, anything will sell. The clearing price is reality. The hard part is for the seller to accept the clearing price, if they can actually afford to sell at the clearing price.

Some sellers put the home on the market priced right from the beginning, and they make a deal quickly.

For sellers, this is not the time to dilly-dally around. If they do dilly-dally around, they’re just going to chase prices lower. Those who panic first, panic best.

It’s not like there is no market out there, and no buyers. There is a market and there are buyers, but the market and the buyers are just a lot lower than where they used to be.

So why is all this happening so fast?

It’s not the economy. People are working, their pay has gone up by the most in four decades. Unemployment is still near historic lows. Actual layoffs and involuntary discharges – meaning people getting fired – are near historic lows.

Even during the Good Times, there are on average 1.8 million layoffs and discharges every month, and that’s part of the normal churn in the huge labor market. Every month for the past two years, including late last year with all the layoff announcements hailing down, the total actual layoffs and discharges were below the Good Times lows before the pandemic, they were at 1.5 million a month or below, the lowest in the data going back over two decades.

Unemployment goes up when there are more of these layoffs, while companies stop hiring, and those that got fired or laid off suddenly can’t get a job any more. And that’s just not happening yet.

Companies have hyped these layoff announcements for months. Usually their stock price jumps when they do. But they’re just announcements, not actual layoffs, and they’re by global companies for their global staff, and many of those layoffs take place in other countries.

Actual layoffs are easy to check in California because companies with more than 75 employees have to report them under the Worker Adjustment and Retraining Notification Act.

San Francisco was the worst off with layoffs, in terms of the size of the labor market. But it only had 7,000 total layoffs since July, despite all the hoopla about the 5,000 layoffs at Twitter alone, and the tens of thousands of layoffs at a bunch of other companies that are either headquartered in San Francisco or have big offices in San Francisco.

And that was as bad as it gets in California. But other companies are hiring, and in California overall, employment has still increased. And the unemployment rate is still historically low.

In other words, there just isn’t a surge in unemployment. The labor market remains tight. People are working and they’re getting big pay raises, and many of those that got laid off are finding new jobs quickly. And that should be great for the housing market.

But this housing market didn’t get tripped up by a surge in unemployment, not even in the Bay Area. Unemployment is a shoe that might drop on this housing market in the future.

What tripped up the housing market so far is the toxic mix of several factors, including:

• A surge in mortgage rates
• Home prices that had exploded into the stratosphere.
• And the sharp drop in stocks, especially the implosion of the IPO and SPAC bubbles, and the plunge in crypto prices have sapped the exuberance, and lots of people lost lots of money.

Home prices had exploded into the stratosphere because of the Federal Reserve’s monetary policies – and nothing else – because of the nearly $5 trillion it printed between March 2020 and March 2022, to repress long-term interest rates, including mortgage rates, and to create the biggest asset price bubble ever.

But now all this is over, now we have raging inflation, the Fed hiked rates, and will hike them further, they will go over 5%, and the Fed is pursuing Quantitative Tightening, and by the end of February, it cut its balance sheet by over $600 billion.

So the Fed is hiking rates and unwinding its balance sheet, and asset prices have come down, including stocks and bonds and cryptos, and housing.

What we’re seeing is the unwinding of the biggest asset bubble ever – including home prices. And so far, this has nothing to do with unemployment or the overall economy. Jobs are plentiful, wages are up, consumers are spending, companies are spending and investing, governments are spending like there’s no tomorrow.

This could change: Unemployment might surge, and job openings could vanish, and consumers who lost their jobs could cut back on spending, and state and local governments that are still swimming in pandemic money, will run out of this pandemic money and then they will have to cut spending. All this is the other shoe that could still drop on the housing market.

But it hasn’t dropped on the housing market yet. The decline in the housing market so far has been driven entirely by the rapid disappearance of free money that everyone had gotten used to since 2008. Housing Bust #2 may turn out to be a sobering trip from the free-money decade in la-la-land, back to normal.

Wolf Richter March 4th, 2023

Posted In: Wolf Street

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