10-15 Hanson…California Housing Bubble 2.0 in Pictures

by Mark on October 15, 2013

Fantastic, everybody made some good money in the past 18 months thanks to the Fed’s aggressive monetary policy — or, to be specific Twist, QE3, and QE4 — which dropped mortgage rates from 5.5% to sub 3.5% almost overnight in late 2011.  This made it so everybody could instantly “afford” 20% more house.  Over the next year this increase in “purchasing power” pushed house ‘prices” higher.  Throw in top aggressive Wall Street and private all-cash “investors” regularly paying 10% to 20% over appraised value / list price for their buy-to-flip/rent schemes and viola’…everybody who owns a home is a lot more “wealthy” — on paper — than 18 months ago.

This note is to throw out some compelling data on where housing actually sits relative to the bubbly years.  And that although it may look different, conditions may be quite similar.   Greed and fear, as they relate to financial assets and decision making, are powerful emotions.   When you see them driving markets, step back, breathe, have a drink, and a think.

Now, of course, I could be wrong about all this.  Airplane loads of foreigners with suitcases full of money to buy houses could start coming to the US in waves;  new-era “Pay Option ARMs”, stated income loans for wage earners, or some other exotic, high-leverage loan program could be introduced/reintroduced;  30-year mortgage rates could plunge below 3%;  wages could soar while unemployment plunges;  Wall Street investors — presently getting probably 3% or less annual return on rentals bought at today’s prices — could suddenly think that’s a great deal and deploy $10s of billion more of other people’s money in rental houses, or a myriad of other things could happen.

But as of now…with demand off sharply post the rate surge;  inventory rising quickly and about to go positive on a YoY basis;  the all-important “distressed” trade, which for the past several years has been responsible for boosting housing through the double-counting of sales and artificial house price appreciation from “flips”;  and new-era investors backing off sharply, the housing market definitely sits at a pivotal point in time.


CA Housing Bubble 2.0 in pictures

Bottom Line:  Unless exotic loans are reintroduced and widely accepted literally overnight, incomes surge, rates plunge to sub 3%, or all-cash buyers/investors substantially increase market share house prices are in store for period of retracement/mean reversion. And at present, all of these variables are going in the opposite direction. This data in this report present a big problem from housing market sentiment and consensus estimates.


When comparing house prices and affordability today vs the bubble years people make a critical error.  That’s, they don’t “normalize” the bubble years metrics to account for the fact that the incremental buyer/refinancer used “other than” 30-year fixed mortgages.  In other words, they forgot about the popularity of “exotic loans” and assume everybody always used market-rate 30-year fixed rate financing.

During the bubble the “incremental” buyer/refinancer used high-leverage loans such as the 5/1 interest only, which was popular from 2003 to 2005 and the Pay Option ARM, which surged in popularity from 2005 to 2007, as rates continued to rise.  This observation changes everything.  Of course, from 2003 to 2007 the “stated income” feature, which allowed everybody to earn exactly what was needed to qualify for the loan, was also very popular. But in order to remain conservative for this analysis it wasn’t factored in.

Bottom line:  When normalizing the monthly mortgage payment required to buy the median priced house in order to account for high-leverage, exotic loans of each period — even though “house prices are not back to peak levels — it’s plain as day we sit in another housing bubble right now.

1) Median CA household income(green) vs income required to buy the median priced house clearly shows that house prices are in “Bubble 2.0″

Looking at the chart below, In the past when the black line poked through the green line (houses became unaffordable as prices surged) new, high-leverage loans were invented to increase affordability.  In 2007/08 when the black line poked through — when we lost all the high-leverage loan programs all at the same time — house prices “reset” lower.

Bottom line:  Once again, expense is going vertical through income and unless we reintroduce exotic loans that are widely adopted literally overnight, incomes surge, rates plunge, or all-cash buyer/investors substantially increase market share CA house prices are destined to fall sharply. And at present all of these variables are going in the opposite direction.

The past year of relative “unaffordability” has been masked by historical numbers of all cash buyers. But as they retreat and the market turns more “organic” by default, then the absolute lack of affordability as shown below will present itself swiftly.

Note, results such as this can be found — not coincidentally — in all of the high-beta, former crash regions/states in which new-era :investors’ swarmed for their buy-to-rent/flip schemes.



2) CA median household income used to buy the median priced CA house also clearly shows the “Bubble 2.0″

Again, this chart has been normalized to account for the fact that from 2003 to 2007 the “incremental buyer” used “other than” 30-year fixed rate mortgages. This created faux-affordability allowing people to keep buying more house.

In 2002, when this metric peaked, the response was to introduce the 5/1 interest only loan, which was widely adopted in 2003 and remained extremely popular through mid-2005. As affordability once again got out of control due to surging house prices from 2003 to 2005, as a response, the Pay Option ARM gained popularity and “affordability” improved through 2007. Then in late 2007/08 when all the high-leverage exotic loans went away at the same time the housing market “reset” to the affordability levels of the market-rate 30-year fixed mortgage and prices plunged. Then in 2012/13 as rates plunged on Twist — and cash buyers swarmed the market masking the “unaffordability” — house prices once again rose in response to the increased affordability.

Bottom line:  Based on today’s rates and house prices, to the organic buyer using a mortgage to buy a house, CA housing is as “unaffordable” as it was in 2005/06.

Pct of Med household income needed to buy med price house


3) Peak CA Monthly Payment buys much less house than from 2003 to 2007

Bottom line:  Just because “house prices” are not back to 2003 to 2007 levels does not mean we are not in another housing bubble.

Based on median income levels and house prices then vs now either exotic loans need to be reintroduced and widely accepted literally overnight, incomes must surge, rates must plunge, or all-cash buyer/investors must substantially increase market share, or house prices are in store for period of retracement/mean reversion.

CA Mo Payment to buy med priced house

{ 25 comments… read them below or add one }

Logan Mohtashami October 15, 2013 at 3:35 pm

When I attended the UCLA Anderson Economic Conference this year the word Zillow used was Boom-let not Bubble, even though their models showed 16%-33% increases all over the state.

CAR had Year over Year 33% returns on home prices.

We have done this dance before and what I warned the NAR in May is coming true. Housing inflation on both fronts is going to impact DTI and LTI capacity



Dan October 15, 2013 at 5:26 pm

Thank you for your Analysis Mark! I’ve been on the fence for many years now and getting your perspective soothes my self doubts. I do wish that you would stop writing “Now, of course, I could be wrong about all this.” as you do in every post, but I get it! :)


yeldon October 18, 2013 at 5:46 am

I do wish that you would stop writing “Now, of course, I could be wrong about all this.”

Heh – speak for yourself there Dan. Equivocation is not a bad thing to express a degree of confidence, or lack thereof with any particular call. I mean compare that to the arrogant, cocksure “we are NOWHERE near the bottom” calls of 2011-2012 when we were, in fact at or even past the bottom.


Crush The Lies October 18, 2013 at 11:17 am

If you think housing has hit bottom you’re going to be shocked over the coming years.


Paul Marshall October 15, 2013 at 10:03 pm

Boomer retirement wave over the coming decade seems to be a significant factor in CA real estate, particularly in the coastal areas… Lots of boomers with lots of East Coast equity are likely dreaming of California lifestyle for their golden years. Your thoughts?


Crush The Lies October 16, 2013 at 5:43 am

“Boomer retirement”?? That demographic trend already passed. The rapidly increasing inventory as a result of boomers expiring has already begun.

And this notion of anyone “dreaming” of a CA lifestyle is comedic. Downright comedic.


Paul Marshall October 17, 2013 at 7:20 pm

You might want to follow your own tagline, Crush The Lies.

Comedic is living in Philadelphia or New York or Chicago, paying taxes out the wahoo, dreary 11 months a year, lemming-like holiday drives to seasonal attractions, brown and grey 6-8 months out your $700/month heat bill winters…
You are living under the typical ignorant view that all things California are horrible.
Come out here Xmas day, walk in a tee shirt on the beach, and report back.

Meanwhile, those of us who have already retired out here, are pretty happy about life.

As far as retirement wave passed – you might want to check your facts. From what I hear, 10,000 boomers are retiring a day for the next 10-15 years. Do the math, and figure out where some of those folks my want to live out their golden years. (hint: not East Coast, not MidWest, not Deep South, not Hot deserts, not rainy NW….)


Crush The Lies October 18, 2013 at 11:19 am

Do your own math my friend. The “boomer retirement” fad ended and they’re now dying off at a rapidly rising rate leaving millions of excess empty houses.

And you can keep California. We’ve all been there, done that. Make sure you shut off the lights on your way out of the god forsaken hell hole.


Mark October 18, 2013 at 11:25 am

In CA there are lots of empty nesters / baby boomers living in big old houses that cost too much up upkeep that they don’t need anymore. High end housing is heavy…low end much better trade. Always has been, always will be. House price compression is next.

AK October 18, 2013 at 10:31 pm


While winters here in CA are nice, weather doesn’t pay the bill, working wages do and California is very middle-of-the-road in wages in the USA.


Fred Mertz October 21, 2013 at 2:36 am

The Baby Boomers are indeed invading the coastal areas. There are 3 in my office (and we are not in CA), including me, who have bought houses in SOCAL in the last 18 months. I will retire in 1.5 years, but one guy has at least 5 years to go. I rented mine out (2 year contract) for $5,400/mo. I paid $1.3M (I bought at the bottom, and there was a pending divorce), and according to Zillow it is now (18 months later) valued at $2.32M.
There is also tons of Chinese money poring into the coastal areas. One guy, working with the same broker as I, has $8M cash (he’s from Shanghai) and wants to buy 3 houses. But there is not enough inventory, as people only sell if someone dies or get a divorce.
My broker is also working with a guy from Penn. who bought a retirement house sight unseen.
It’s going crazy here. My house hits new highs each month. There is very limited SOCAL coastal inventory, and because of the questionable policy of the US, anyone, anywhere is the world can buy it. There are no shortage of rich people in the world who want perfect weather, and a “safe” place to park some capital (and great schools, etc.).

Crush The Lies October 22, 2013 at 4:58 pm


CA housing demand has all but collapsed. And more to the point, prices have been falling since June. Clearly because prices are massively inflated.

The Bert October 22, 2013 at 8:21 pm

Great Schools? Hahahahaha. You must have not visited Los Angeles before you bought. Though I do agree that prices keep going up in the highest end areas. I can’t afford it but I believe there always will be wealthy people who can and are willing to pay whatever it takes to live in this great weather. Congrats on your purchase!

AK October 28, 2013 at 11:09 am


The amount of _foreign_ money, per annum, invested in California is 7 to 8 billion dollars, about 3 to 4 billion Chinese money. These are reasonably well-quantified numbers and not huge versus the overall market. In the short term, such relatively small amounts of money can affect the marginally-determined price of housing, but will not change long-term pricing.

Again, so much of this is about pure math rather than anecdotal evidence. Also, everyone everywhere assumes where they buy property is somehow special. This is known as optimism bias and again not necessarily reflection of reality. Whatever rebound you are seeing in housing prices, especially in SoCal has to do with Fed policy and sentiment rather than fundamentals.

The data are already coming in that sales are dropping nationwide and even more dramatically in the Western regions. While hope and stimulus can decouple an asset from its underlying value for a short period of time, cold hard math will eventually win.

black dog October 16, 2013 at 8:25 am

Fantastic, everybody made some good money in the past 18 months thanks to the Fed’s aggressive monetary policy — or, to be specific Twist, QE3, and QE4 — which dropped mortgage rates from 5.5% to sub 3.5% almost overnight in late 2011.

a quibble.

Fed’s aggressive monetary policy lowering interest rates. I think the OPPOSITE is true. QE2 ran from november 2010 to june 2011 … 10yr treasury yield up over 100+ bps from nov10 – april11 … yields started to drop when investors thought QE about over. Twist (swapping shorter duration Ts for longer … balance sheet neutral) did not start till sept 2011. QE3 did not start till sept 2012 (and 10yr yield meandered up till rolling over in march 2013 and then ascending again first of may 2013 … imo, investors front running “taper” … and once it becomes “news” (and stock market no longer gets its POMO “hit”) rates will drop … again.

Since the recession ended, Interest rates have dropped most when Federal Reserve’s balance sheet has been “neutral” … not when increasing. IMO, in large part due to Bernanke Put … why should investors settle for a measly few percent yield in the bond market when the stock market has been a “sure thing” (up over 100 percent past 4 years).


Brant Gaede October 17, 2013 at 12:51 am

Prices are made at the margins and the margins are determined by inventory and demand. Part of demand is the expectation of house prices going up and continuing to go up so the bubble buyer doesn’t care about affordability sans that. The prices may be in a bubble but the buyer psychology isn’t. The real bubble is all the homes not being sold because the would be sellers can’t afford to sell. If they could they would swamp the market. It is part of the gigantic debt bubble.


Goldman October 17, 2013 at 10:01 am

In Greater Boston area the Housing Inflation looks directly correlated to people taking on the highest level of Mortgage Debt in the history of Massachusetts (and yet many properties still aren’t quite hitting their 2005 highs)
Increase Debt is the major contributor to increasing values – I find few all cash buyers in any market I look at.
Here are samples of real estate transactions in the last month:

Here are a few sample transactions for Burlington-Mass (which was home to Sun Microsystems during the DotCom Boom) and here is what I found:

2 Woodcrest – Burlington – sold for $439,000 on 9/17
New Mortgage is $439,000 – No 20% downpayment
In 2004 this property sold for $423,000 – mortgages totaled approx $400K.

4 Stewart Burlington – sold for $600,000 9/16/2013
New Mortgage is $480,000 – nice to see 20% down
In 1999 this house sold for $367,000 – it was brand new – 7.4 % 30 year Mortgage rate. (the DoCom bubble was in full swing in Mass).
Money is 40% cheaper to borrow today the House sold for 38% more today than in 1999 (lower interest rates= people borrow more =houses go up)

8 Gibson Burlington sold for $480,000 on 9/9/13
New Mortgage $384,000 – great down payment
Sold in 2004 for$460,000 with a $368,000 Mortgage
Money today is 25% less expensive to borrow, yet this home only went up by 4.16%

13 Mountain Rd – Burlington sold for $385,000
New Mortgage is $371,500

5 Marret – Burlington sold for $570,000 on 9/4/13
New Mortgage is $484,4000
2002 it sold for $469,000 with a Mortgage of $270,000 (in the midst of the DotCom bust)
The Mortgage rate in 2002 was approx 6% – borrowing costs are 25% less today – the 2013 price is 21.5% higher than 04

8 Richardson Burlington sold for $410,000
New Mortgage is $369,000
sold in 2003 for $357,000 – Mortgage was $316,000
Mort rate in 2003 was approx 5.5%-borrowing today is 18% cheaper – result – todays buyer paid 14% higher price

Debt is driving Real Estate and yet it looks like the lower rates are having less impact as time rolls on.


Mark October 18, 2013 at 8:09 am

great data


Gary October 18, 2013 at 11:15 am

I live in Southern California and it seems to me that housing prices went too high,then took years to bottom out and now they have come back up to where they should be, and leveled off. Now if we get our countrymen employed and we get our goverment to balance the budget….this country will be fine.
(Great post Paul Marshall)


Crush The Lies October 18, 2013 at 6:59 pm

And now they’re too high again and on the precipice ready to dive.


Bubs October 20, 2013 at 6:41 pm

Crush the Lies,
I agree with you. House prices in So Cal are ABSURD!!!!
Not based on fundamentals at all. At least the stock market rebound can be explained by corresponding business earnings but the fundies of the housing market are just not there in a bubble area like California


PD Quig December 11, 2013 at 9:03 am

Yes, corporations have managed to wring out profits from declining revenues, but you might want to think about where the markets would be without the $85B / month the Fed is pumping into them (Hint: no higher).


rj chicago October 23, 2013 at 10:54 am
rj chicago October 25, 2013 at 8:04 am

And more from our friendly syndicate buyers. This is not a healthy market.


rj chicago November 6, 2013 at 9:08 am

What does this fortell – seems the young ‘uns ain’t moving out from the basement.



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