With the U.S. housing market having recouped most of its pre-financial crisis price levels (exceeded in some markets) in conjunction with the Federal Reserve having engaged in ZIRP (zero interest rate policy) for an extended period of time, is the market once again facing a moral hazard?

First, how would one define moral hazard vis a vis the real estate market?

Moral Hazard: Using the period of irrational exuberance in terms of housing/mortgage demand and lending practices prior to the 2008 financial crisis as an example, moral hazard existed then on two fronts:

1. Lenders were very eager to approve loans prior to the mortgage crisis.Some mortgage brokers encouraged “subprime” borrowers to lie, or they altered documents to make it appear as if borrowers were able to afford loans that they really couldn’t afford. For example, sometimes inaccurate income numbers were reported, or no documentation was required to prove claims about ability to repay.Why would lenders hand out money when they don’t really know if they’ll get repaid – especially if they have to lie to get the loans approved? In many cases, the lenders were only originating (or selling) the loans. After the loan was approved and funded, lenders would sell the loans to investors – who later lost money. In other words, the lender took little or no risk (but the lender had an incentive to put risk on somebody else, because originators get paid for making loans).

   What’s more, lawmakers and the public became scared. They worried that if major banks collapsed (some of them were loan originators, while others held risky assets), they would bring down the US economy – not to mention the global economy.

2. Borrowers – Moral hazard also became an issue for borrowers. As millions of homeowners struggled to pay their mortgages and defaults skyrocketed, government programs offered relief. People could avoid foreclosure thanks to funds and guarantees from the US government. Some worried that borrowers would actually have an incentive to walk away from their mortgages: they were underwater on home loans, and some might be tempted to get government aid that they didn’t need. In some cases, their credit might suffer, but in other cases borrowers would come out unscathed (in some ways at least –struggling borrowers almost certainly experienced financial hardship and emotional stress). (Source)

An article at Econimica written by Chris Hamilton explores the question of whether the US housing market/US economy is once again facing moral hazard is discussed and explained…

The US Real Estate Big Picture…A Thesis in Moral Hazard

Economists and the like often get highly academic and granular in their discussions of the economy and markets. It needn’t be so…with the idea of KISS (keeping it simple, stupid)…here’s a look at the US housing market which has almost regained it’s 2007 bubble valuations.

US Housing Valuation Index

What Factors Drive Housing?

Since 1980 (and even before), there has been a stable ratio of new homes built vs. core population growth (15-64yr/olds), and net new full time job growth. Historically homes are purchased by those with good incomes (full time jobs) and in their prime working years (15-64yrs/old). The fact the Federal Reserve has driven it’s federal funds rate down 97% resulting in a decline in 30yr mortgage rates of 80%+ is probably noteworthy in the rising prices of homes (and rising need for homebuyers to take on greater debt and leverage).

This isn’t to say 65+yr/olds don’t buy homes, but they typically already own a house that they are also selling on the other side of the transaction. 65+yr/olds are typically net downsizing at this point in their lives. However, since ’08 a wealthier minority have opted out of bonds and into rental RE for the cash flow. Still, to support greater demand for housing…you need a younger population of buyers with the income to support the market growth.

The chart below is an overview since 1981 of new home creation, core population growth, and net new full time job growth per period.

1981–>94
——>1 new home per 1.5 net new full time jobs
——>1 new home per 2.1 persons growth among working age population
•9.5 million new homes added
•21 million increase, 15-64yr/old population
•15 million net new Full Time jobs
—>30yr mortgage 17.8% to 9.1% (-49%)

1994–>07
——>1 new home per 1.5 net new full time jobs
——>1 new home per 2 persons growth among working age population
•14.5 million new homes added
•30 million increase, 15-64yr/old population
•23 million net new Full Time jobs
—>30yr mortgage 9.1% to 6.6% (-28%)

2007–>16
——>1 new home per 0.5 net new full time job (RED FLAG)
——>1 new home per 2 persons growth among working age population
•5 million new homes added
•10 million increase, 15-64yr/old population
•2.6 million net new Full Time jobs
—>30yr mortgage 6.6% to 3.4% (-47%)

The rest of the article makes for an interesting read but, if you’re stopping here, then to make a long story short this is the articles conclusion…

Conclusion:

Given central banks are all in and have no credible ideas (or credibility period), a NIRP driven speculative new housing bubble (for a population that is barely growing…hello China?) seems most likely. If you haven’t already, get busy front running the next moral hazard moonshot and then stay tuned. Because as you read this, central bankers are already devising their next (even more destructive) “plan”.