“Bubble Watch” digs into trends that may indicate economic and/or housing market troubles ahead.

Buzz: It’s a darn good bet that home-price appreciation will cool after the Federal Reserve admitted it underestimated the inflationary impact of its pandemic-era cheap money policies and will begin taking measures that will lift interest rates in 2022.

Source: My trusty spreadsheet looked at 33 years of mortgage rate stats from Freddie Mac and how increases in financing costs impacted the median sales price of all residences in the six-county Southern California region, as tracked by DQNews.

The Trend

It’s time for a refresher course on what can happen to local housing when mortgages get pricier. It’s not always a disaster for home prices.

Looking at all 12-month periods since 1988, Southern California home prices appreciated at an average 5.4% annual rate. Yes, it’s not always up as prices declined in 23% of the 12-month periods.

But mortgage rate increases — when they rose over a 12-month period — occurred 32% of the time.

Please note when rates were rising, prices had gained an average 8% in the previous 12 months. Rates typically jump in times of economic strength. And growing demand usually boosts prices for goods, services — and money.

Ponder November’s results for the region: a $693,500 record-high median price after a 15.6% gain in a year where rates went from 2.77% to 3.07%.

The Dissection

It takes time for rising rates to hit the economy — and the cooling effect can linger.

In the 12 months after rates rise, Southern California home prices fell 19% of the time since 1988, with the biggest one-year drop being August 2008’s 34% tumble.

Shrinking rates of appreciation are a more common outcome when loans get costlier. Southern California appreciation cooled 12 months after rate rises 61% of the time.

Price increases averaged 4.3% in the year after a rate rise — that’s 3.7 percentage points below the pace of gains at the start of a rate rise. Roughly speaking, appreciation was sliced by half.

Next, look at the second year after rates rise.

Price drops happened 23% of the time since 1988, with one-year drops as big as January 2009’s 40% implosion.

Again, shrinking appreciation is the more common result — occurring 49% of the time. Southern California home prices averaged just 2.1% gains in year two, a 2.2-point drop from the previous year. Or cut in half, again.

How bubbly?

On a scale of zero bubbles (no bubble here) to five bubbles (five-alarm warning) … FIVE BUBBLES!

Let’s be honest. The Fed is raising rates to cool inflation, and the pandemic era’s bubbly home-price surge is a prime target.

Costlier mortgages should diminish the bubble, eventually. History says in the two years following rate increases, Southern California’s home appreciation on average is 74% slower — from 8% gains down to 2.1%.

The big question is whether the Fed can deftly use its rate-setting powers to smoothly cool the economy and its notably frothy real estate market.

Be warned, it doesn’t always go as scripted for real estate.

Forget the early 1980s when the Fed intentionally iced an overheating economy — slamming housing in the process — with double-digit interest rates. And forget the Great Recession, which clobbered real estate for many reasons other than preceding rate hikes.

Rather, try to recall the early 1990s.

The Fed felt that in 1993 it had done enough to boost the economy after a mild U.S. recession that was more intense in California. Mortgages rates, for example, had fallen below 7% for the first time in more than two decades. (Yes, 7%.)

The Fed’s “tightening” of that era translated to mortgages staying above 7% for five more years. That expensive financing and other economic challenges such as a declining local aerospace industry pressured housing.

Southern California’s median price of $152,860 for October 1993 — then the record high — wasn’t topped until September 1998.

That’s essentially five years of zero gain. Another way that bubbles can deflate.

Jonathan Lansner is the business columnist for the Southern California News Group. He can be reached at jlansner@scng.com