Is the second U.S. housing bubble of this century starting to deflate?
Published in Housing Finance International Journal.
Although it is only one-quarter over, the 21st century has already featured two massive U.S. house price bubbles—a Double Bubble. The first one ended in a terrific bust, needless to say (or is it possible that group memory is already fading?). The second one has made houses widely unaffordable when mortgage interest rates are at normal levels. It may be topping out now, in the third quarter of 2025.
The inflation of the infamous first 21st-century housing bubble ran for over seven years, beginning in 1999. The government and private actors had both pursued riskier mortgage loans, the Fed sought a housing boom to offset the dot-com bust, and together they got a housing bubble. It had doubled average house prices by the time it topped out in 2006. This bubble was deflating by early 2007 and shriveling by late 2007. Average U.S. house prices fell by 27% over a painful period of about six years, finally bottoming in early 2012. This timing is close enough to always make me think of the seven fat years followed by seven lean years foretold by Joseph after Pharaoh’s dream of fat and lean cows in the Book of Genesis.
Neither the American nor the international financial system was as prepared as Joseph for the lean years. The price collapse intertwined with the unraveling of housing finance and set off the “Global Financial Crisis” of 2007–2009, including the panic of 2008 and the failure or distress, and government bailouts of numerous famous firms. These included, for example, the formerly AAA-rated global insurance company, AIG. As Walter Bagehot had correctly written 135 years before, “Every great crisis reveals the excessive speculations of many houses which no one before suspected.”
The emergency reactions of the Federal Reserve to the collapse of the first bubble and later to the Covid panic, as they continued for 14 years (2008–2022), featured nearly zero nominal short-term interest rates, negative real interest rates (that is, interest rates less than the inflation rate), and an entirely unprecedented $2.7 trillion investment in long-term, fixed-rate mortgage securities on the Fed’s own balance sheet. For its entire previous history, the Fed had never owned any mortgage securities. This radical action made the Fed the largest buyer of mortgages and drove the 30-year mortgage lending rate to under 4% and then under 3%, all stoking the second house price bubble. In addition, the Fed invested in $2.4 trillion of long-term Treasury securities to suppress long-term interest rates in general, while it monetized government deficits.
We can place the beginning of the second house price bubble in 2015. By then U.S. house prices had been rising again, but instead of returning to their long-term trend of increasing at a little over the inflation rate, they ran upward far faster than that, with a particular upward spike in 2020–2021.
At that point, 30-year fixed-rate mortgage loans were exceptionally cheap—their rates were pushed down by the Fed to lows of merely 2.7% in 2020 and 2.8% in 2021. The result is that buyers paid higher prices for their houses. For the twelve months ended July 2021, average house prices rose over 19%. Overall, in the inflation of the second bubble between 2015 and 2025, average house prices again doubled.
In March 2022, the Fed very belatedly stopped expanding its mortgage portfolio and started to increase short-term interest rates. Mortgage interest rates rose to over 4% and then over 5% in May of that year. In other words, the rates were returning to historically normal levels, but the impact of their rise on monthly payments compared to a 3% mortgage was very large.
Many people, myself included, thought average house prices would then necessarily fall. They did go down about 5% from an interim peak in June 2022 in the second half of that year, but then most surprisingly started back up and reached new highs, in spite of the interest rate on mortgages rising to 6% to 7% or more. The 2025 highs were almost 80% over the peak of the first bubble and were 7% over what had looked like the top in June 2022.
But now it appears that the market really is putting in the top of the long second U.S. house price bubble of this century. The AEI Housing Center reports average house prices increased only 1.3% for the year ending in August 2025, less than the general inflation rate, and forecasts 0% average house price growth for the year 2025 and –1% for 2026.
The financial commentary Wolf Street reports that for July 2025, house prices fell on a year-over-year basis in 20 of the 33 U.S. metropolitan areas it tracks. It adds that prices of mid-tier houses have declined more than 10% from their 2022 peaks in twelve U.S. cities, with the five biggest falls being in Oakland, California: –23%; Austin, Texas: –23%; New Orleans, Louisiana: –18%; Cape Coral, Florida: –18%; and San Francisco, California: –16%.
Even after these reductions, house prices are still at highly inflated levels, so the price deflation should continue. Correspondingly, inventories of houses offered for sale are rising rapidly while the volume of house sales is low, and home builders are having to offer significant price concessions to sell new houses.
If the second bubble is finally starting to deflate, how far can prices fall and for how long? After ten fat years, how many lean years could there be this time, even if the U.S. has avoided the egregious credit mistakes of the first bubble? Will the Federal Reserve be tempted to get back into expanding its mortgage portfolio? These are questions to which we don’t know the answer.
But we know for certain that highly leveraged real estate combined with extreme movements in central bank money printing create remarkable adventures in house prices and housing finance