Housing is traditionally a very volatile sector of the economy. It tends to lead the business sector (indeed, some economists like Ed Leamer of the UCLA Forecasting Group say that housing IS the business cycle). Housing is subject to booms and busts. A case in point is the major housing boom of the early and mid 2000s, that ended up as a major bust between 2006 and 2010. The boom was marked by a huge run-up in housing prices and substantial over-building. Housing affordability fell dramatically even as the homeownership rate increased. The supply of vacant homes increased massively.

The excesses were largely eliminated in the subsequent housing bust. Affordability has increased as housing prices have fallen and mortgage loan rates are near all-time lows. The stock of vacant homes is near normal levels. Demographics look positive as well. Each year about 4 million young people reach the age of thirty, historically the typical time for first time home ownership (granted, the rate of household formation is lagging behind as many young people today are slow to venture out on their own). The rate of homeownership has declined to historical averages, after rising sharply during the housing boom.

Based on these fundamentals, we perhaps should have expected that a very strong housing recovery would be underway. But if we expected that, we would be wrong. Since the bottom in late 2010, housing starts have picked up 20% or so, but that still leaves the pickup in construction activity well below the improvement in prior cycles, even those that began at higher levels of activity.

Bottom line, housing remains weak. Why is that?

One possibility is simply that the traditional home affordability measures are misleading. The home affordability index published by the National Association of Realtors asks the following question: what percent of the median priced home can be purchased by the median income family given the current market rate for 30-year fixed rate mortgage, and assuming a down payment of 20% and a debt-to-income ratio of 25%. This measure reached a record high of 196 in 2012, and has receded to a still high by historical standards 175 as housing prices have picked up since then.

One factor that the affordability index does not take into account is the amount of consumer debt, in particular student loan debt that has now reached $1.2 trillion. High levels of student loans impair the ability to save up for a down payment and increase the overall debt burden. Both factors surely impact the mortgage underwriting decision, even they don’t show up in the affordability index.

Another issue is expected financial return from home ownership. In the past, owning your own home has been widely perceived to be the surest path to financial security. So long as home prices increase, and mortgage amortization reduces indebtedness, home equity builds up. The rate of return is amplified by imputed rent (you pay rent to yourself instead of a landlord) and various tax benefits from home ownership. While the long-term return to homeownership has been challenged by some economists, notably Robert Shiller, the fact remains that home equity has been the primary component of net worth for the majority of households.

However, confidence in home ownership as a means to wealth enhancement was obviously shaken if not shattered by the widespread declines in home prices between 2006 and 2010. Much like the generation that grew up during the Great Depression swearing off stocks for decades, a similar phenomenon may be going on with the Millennial generation and home ownership.

Compounding the concern about home price appreciation is concern with wage growth. The recovery from the Great Recession has been mediocre and likewise the rates of job and wage growth. While the level of wages is captured by the affordability calculation, which as noted above is looking pretty good, so long as economic prospects appear to be bleak, who has the confidence to undertake a huge investment?

Finally, mortgage underwriting standards today are significantly tighter compared to the lax standards prevalent certainly during the prior housing expansion. Naturally, tighter underwriting standards mean that a smaller percentage of the potential home buying universe can qualify for a loan.

The combination of large consumer debt, concern over future housing appreciation and wage growth, and tougher mortgage standards appears to have diminished the appeal of home ownership, at least temporarily. Eventually, there will develop pent-up demand by first-time buyers as young people become frustrated with apartment life or hanging out with Mom and Dad. But there is little sign of that at present.