“Bubble Watch” digs into trends that may indicate economic and/or housing market troubles ahead. This time, a more philosophical analysis.

Bad news: California home prices look bubblish.

Good news: Values don’t have to crash painfully to correct the overpricing.

Californians were left with understandable scars after the Great Recession shredded psyches, careers, checkbooks and net worths. But that doesn’t mean every time homebuyers get a little nutty — a well-documented California habit — sharp and swift price declines must follow.

The past year’s surprisingly strong home prices in a pandemic-tattered economy were unnerving. It was a surge propelled primarily by historically low mortgage rates that helped balloon house hunters’ urge for larger living spaces due to  revamped coronavirus lifestyles.

“Bubble” means the price of an asset has exceeded its underlying value. Nobody has clearly explained to me how housing will remain unscathed after the virus is knocked down and the bargain financing disappears — even if the Federal Reserve gives plenty of warning, as it’s promising.

Please note, just a 1-percentage-point jump in mortgage rates from today’s historic lows below 3% would cut a typical house hunter’s buying power by roughly 12%.

So, I figured a history lesson was in order. I filled my trusty spreadsheet with California home price stats dating to 1975, using a slow-moving Federal Housing Finance Agency index. What I discovered were three distinct “corrections” — defined by me as extended periods between this index’s record highs.

Yes, “it’s different this time” can be true. Each one of these painful periods has its own plot — from backstory to duration all the way to the ending.

1980s: Quick fix

An inflation battle created a short, mild price correction over two years.

California home prices had surged at a rate of 16% annually for seven years to record highs in the fall of 1981. These were turbulent times. Global instability and oil shortages created by an Arab embargo of U.S. imports help flame inflation to 9% that year — making those housing gains, not to mention paychecks, worth much less.

Then the Federal Reserve took harsh action to temper inflation, intentionally chilling the economy. Yes, it seems central bankers often have a role in real estate. Interest rates soared and mortgages hit unfathomable heights above 18%.

But prices during this correction fell by only 11% to the cycle’s bottom — and would hit a new high in the fall of 1983 … as rates dropped to, gulp, 13%!

1990s: Long malaise

Poor economics translated to a housing malaise that lasted much of the decade.

When the Fed stopped tethering the 1980s economy, California business and housing boomed — although mortgages never got much below 9%. The housing-friendly savings and loan industry actively lent in a last-ditch attempt to rescue itself. Prices appreciated at a 10% annual rate for 7 years to a record high in the summer of 1990.

Then California struggled to shake a minor national recession. S&Ls went away, and the end of the Cold War decimated the state’s aerospace industries. Mortgage rates fell under 7%.

But housing’s correction of the 1990s is often forgotten due to its unusual pain.

A slow, meandering economy meant California housing’s next record high wouldn’t be seen until the fall of 1998 — yes, eight-plus years between peaks. But during this extended sluggishness the price index fell by only 13% to its bottom.

2000s: Big burst

A painful plunge following gobs of real estate insanity meant 12 years between peaks.

You could have expected the ’90s feebleness to roll into a significant rebound. There was pent-up housing demand. Plus, the California business climate was super-heated by the emerging dot-com economy. Prices rose at a 14%-a-year pace for eight years.

The real estate momentum seemed unstoppable as prices shrugged off a temporary collapse of technology industries, the 9/11 terror attacks and a mild national recession. How? Aggressive lenders and willing borrowers were doing really stupid things — like buying homes few could afford.

The correction of these horrible business practices, poor regulation and individual mistakes burst the bubble into the global Great Recession. California housing crashed into a tumble that sliced 41% off the price index from its summer 2006 top.

It would take 12 long years — and mortgage rates below 5% — to erase those losses and reach a new peak in the summer of 2018. And since, the housing market’s generated eight more price highs as the Fed further juiced housing with rates below 3%.

Bottom line

History tells you the Great Recession’s housing pain was gruesome — and quite likely, not much of a parallel to the pandemic era. However, that doesn’t mean 2021’s overheated housing markets won’t face noteworthy challenges.

Perhaps today’s homebuying conditions are more akin to the early 1980s when the Fed was trying to fix a broader economic challenge and the business climate responded favorably. That era’s home-price correction was quick and modest.

And don’t ignore the 1990s as a possible pandemic guidepost. That decade’s drawn-out economic weakness created a lengthy funk for California’s housing markets.

Is what amounts to eight years of zero home price appreciation a “crash” or a “correction”?