Bank of America analysts do not see a housing collapse like in 2008

Bank of America economists dismiss fears of a housing collapse like the one experienced in 2008. Instead, they say, the market is more reminiscent of the market four decades ago.

Unlike 2008, there is no evidence of over-development by builders or over-leveraging by home buyers and homeowners. The housing market today is largely dealing with the fallout of tight monetary policy - similar to 1980.

However, there are some key differences, but the main takeaway from Bank of America is that housing still has a tough road ahead.

"Looking back at previous housing downturns, we think the 2008s is a better analogy for today's market than the housing crash of XNUMX," wrote Jasio Park and Michael Gapen, U.S. economists at Bank of America Securities, in a note. Still, "while rates are likely to remain high for a longer period of time, we are wary of the potential turbulence ahead."

This is not 2008

In the years before 2008, builders were on a construction binge, which led to "overdevelopment," they wrote. While the construction of houses increased during the last year, the construction still lags - by far - the pace of the developers registered from 2000 to 2006.

Home loans were also easier to get in the years leading up to 2008 with looser standards being the norm. Lenders did not check income, granted loans to risky borrowers and allowed purchases without down payment. They also peddled irresponsible adjustable rate mortgages, which then had balances rise and had no cap on interest rate increases.

Buyers now face higher standards - and did so even during the home buying years of the pandemic. This is a big difference, the economists noted.

"Mortgage debt was 65% of disposable income in the second quarter of 23, compared to a record high of 100% at the beginning of the financial crisis," they wrote. "The ratio between mortgage debt and real estate assets (that is, loan to value) was 27% in the second quarter of 23, significantly lower than in 2010."

More of an 80's feel

Instead, the economists argue, the housing market resembles the early 80s in several key ways. Then inflation was also high. In the years leading up to 1980, the consumer price index - a carefully watched measure of inflation - jumped to 14.8% on an annual basis.

To combat rising prices, the Federal Reserve raised interest rates, resulting in a doubling of mortgage rates from about 9% to 18% by 1981, which hurt the housing market just as baby boomers were entering their prime home-buying years.

Sound familiar?

Fast forward to June 2022 when inflation has reached its highest level in more than four decades, with the consumer price index rising 9.1% year over year. The Fed, recognizing that inflation was a growing problem even before that, began its interest rate hike that March.

As in the early 30s, the Fed's actions indirectly affected mortgage rates, with the 3-year fixed mortgage rate more than doubling from 2022% in January 7.49 to XNUMX% this month. The impact hit another large generation entering their home buying years: the millennials.

"While home sales can be supported to some extent by activity from this prime age group, continued high mortgage rates should make the decision to purchase a home more challenging in the near term," they wrote. "Indeed, positive demographic data was not enough to hold the market in the 80s and will likely not be enough to stimulate the market this time."

Other housing indices then and now are also similar.

For example, home prices jumped more than 16% in 1979, then fell as year-over-year growth slowed to just 0.5% by 1982. Existing home sales fell 54% from peak to trough, revealing how much demand had fallen.

Similarly, house prices climbed nearly 21%, before flattening to a 0% annual growth base in June this year. Sales of existing homes fell by almost 40%.

Still, there is a marked difference between now and then when it comes to leverage.

Mortgage debt to disposable personal income reached 65% in the second quarter of the year compared to a record ratio of 45% in 1980.

"At the beginning of the flush, this difference may seem alarming, but one explanation is that the speed of growth in house prices has exceeded income growth over the years," the economists wrote. "Household balance sheets are in very good shape at the moment, and leverage does not seem to be a major concern."

Looking ahead, Bank of America expects limited housing inventory, high prices and labor shortages to be headwinds for some time. Affordability continues to be an issue as home price growth still outpaces income growth. In 2022, the median sales price of new single-family homes was more than five times the median household income, Bank of America notes.

"We remain cautious of the potential turbulence ahead," the researchers noted. Only reducing rates can improve affordability and create a "stable and healthy housing market".

Bank of America analysts expect the Fed to raise interest rates by a quarter of a point in November and they expect a rate cut of the same magnitude in June of next year, according to a company spokesman. By the end of 2024, they expect rates to drop three-quarters of a point and then drop another full point in 2025.

"Until then, hold on tight," the researchers wrote about the housing market. "It could be a challenging ride."