Will This Be Another Housing Bubble, Like 2006?: 3 Possibilities

The housing market can be unpredictable, and past experiences often serve as valuable lessons for predicting future trends. Here are 3 potential warning signs that may indicate another housing bubble is forming:

Warning Sign #1: Increased Inventory and New Construction

In the years leading up to the 2006 housing market crash, there was a surge in new construction and inventory. This increased supply of homes led to a decrease in prices, which ultimately contributed to the crisis.

While some may argue that this is just a normal part of the real estate cycle, others point to the sheer scale of new construction and inventory as a warning sign. Consider the following factors: - In 2005-06, the median home price in many areas dropped by over 20% due to increased supply - This surge in new construction was largely driven by low interest rates, making it easier for people to enter the market with less-than-optimal financial conditions

Warning Sign #2: Housing Prices vs. Income Growth

Housing prices often outpace income growth, creating a bubble that can eventually burst. This is because housing prices are typically driven by demand, rather than economic fundamentals like employment or wages.

The chart below illustrates the relationship between median home price and household income in various markets over the past few decades: Median Home Price vs Household Income

Note how housing prices have historically tended to outpace income growth, creating a narrative of unsustainable demand

Warning Sign #3: Credit Spreads and Interest Rates

During the 2006 crisis, credit spreads between mortgage-backed securities (MBS) and Treasuries became extremely wide, indicating investor risk aversion. When interest rates rise, credit spreads narrow, as investors become more comfortable lending to borrowers with lower credit scores.

A similar scenario is unfolding in the current market. Credit spreads are widening between MBS and Treasuries, while interest rates remain low. This suggests that lenders may be becoming risk-averse, reducing their willingness to lend to lower-income borrowers.