In 2005, Fed Chairman Alan Greenspan told Congress that “a nationwide housing price bubble does not seem likely.” Of course, not only had a housing bubble formed, it was nearing its peak just as Greenspan was delivering this message on Capitol Hill.
Fast forward to 2022, and the scars of the last bubble have clearly made economists less scared of recognizing a housing bubble, even though they think the bubble might be less dangerous than the one that formed. at the beginning of the 2000’s.
On Tuesday, the world’s most powerful economist did just that: Speaking at a Brookings Institute event, Fed Chairman Jerome Powell told the audience that soaring oil prices real estate during the pandemic real estate boom qualifies a “real estate bubble.”
“Coming out of the pandemic, [mortgage] rates were very low, people wanted to buy houses, they wanted to get out of the cities and buy houses in the suburbs because of COVID. So you really had a real estate bubble, you had real estate prices going up [at] very unsustainable levels and overheating and that sort of thing. So now the housing market will come through the other side of that and hopefully come out in a better place between supply and demand,” Powell said.
According to Powell’s past statements, this process of “equilibrium” in the US housing market has already begun. In June, Powell said soaring mortgage rates would help “reset” the US housing market. Then in September, Powell told reporters that we had officially entered a “difficult [housing] correction” which would restore the “equilibrium” of the market.
This “bubble” acknowledgment by Powell follows an article published in November by the Federal Reserve Bank of Dallas under the title “Skimming US Housing Froth a Delicate, Daunting Task”. The article argued that policy makers should try to deflate the bubble rather than burst it.
“In the current environment, with demand for housing showing signs of slowing, monetary policy must carefully thread the needle to bring inflation down without triggering a downward spiral in house prices – a sell-off of housing – which could make an economic downturn worse,” writes Martínez-García at the Dallas Fed. “A severe housing crisis due to the spiraling pandemic is not inevitable. Although the situation is difficult, it remains a window of opportunity to deflate the housing bubble while achieving the Fed’s preferred outcome of a soft landing.
To better understand where we might be heading next, let’s take a deeper look at Powell’s comments on housing.
The U.S. real estate market has become objectively buoyant during the pandemic. In fact, data produced by the Dallas Fed (see chart above) shows that house prices in 2022 are actually more detached from underlying fundamentals than they were in 2005 and 2008.
Over the coming year, these detached fundamentals should begin to heal a bit. It’s a view shared by companies like Morgan Stanley, Zonda, KPMG, John Burns Real Estate Consulting, Moody’s Analytics, Goldman Sachs, Wells Fargo, Fannie Mae and Zelman & Associates. These companies estimate that affordability “under pressure” (i.e. mortgage rates jumped 3 percentage points just after US home prices jumped 40%) will lead to further decline in home prices in 2023. If U.S. home prices—which are already down 2.2% from their June 2022 peak—continue to fall and incomes continue to rise, fundamentals would indeed begin to come down to earth.
That said, Fed officials do not believe the ongoing housing correction is a repeat of 2008.
“From a financial stability perspective, we haven’t seen in this cycle the kinds of poor underwriting credit that we saw before the Great Financial Crisis. Housing credit was much more carefully managed by lenders. C it’s a very different situation [in 2022]it has no potential, [well] it does not appear to have financial stability problems. But we understand that [housing] That’s where a very important effect of our policies is,” Powell told reporters earlier in November.
You see, the last housing bubble was basically a different story. At the time, zealous lenders were giving mortgages (or better, subprime mortgages) to people who historically would not have qualified. As this credit flowed in, it contributed to both a construction boom and a house price boom. However, once Fed tightening triggered a housing market correction in 2006, that construction boom turned into a supply glut and those bad debts turned into a foreclosure crisis. This combination of oversupply and “forced selling” caused U.S. home prices to drop 26% between 2007 and 2012.
Although Fed officials acknowledge that we could see a “material correction” in house prices, they don’t think it would be as damaging as the crash of 2008. The reason? In the years ahead, the Fed believes we shouldn’t have to worry about a foreclosure crisis or a massive supply glut.
A combination of high sales and supply chain issues has seen homebuilders rack up a backlog of unfinished projects during the pandemic. On the one hand, as homebuilders rush to unload these homes, that could put downward pressure on home prices in 2023. On the other, that’s just not enough homes to solve the housing shortage in the country. Powell acknowledged it on Wednesday.
“Nothing of the sort [the ongoing housing correction] affects the longer term problem, which is that we have a built country and it is difficult to get zoning and difficult to get housing built in sufficient quantities to meet public demand” , Powell. “There is a longer-term housing shortage.
So while skyrocketing mortgage rates may help “balance” the housing market by lowering house prices and giving stocks (see chart above) room to grow, the trajectory of the market may not favor buyers for a long time.
Let’s be clear: no one really knows how the ongoing real estate correction will actually unfold. There are simply too many question marks. Is inflation falling rapidly and taking mortgage rates with it? Or is inflation proving sticky and therefore necessitating higher rates for longer?
But we can say, based on past history, that whatever comes next will surely vary depending on the housing market.
One of the main reasons this will vary is that the fundamentals vary so much from market to market. Look no further than Cleveland and Austin. The former has seen a modest housing boom during the pandemic, while the latter has seen house prices soar by more than 70%. Of course, now that the housing market has changed, Austin (which Moody’s Analytics deems “overvalued” by 61%) has already slipped into a sharp correction while Cleveland (which is “overvalued” by 15%) has simply slowed down.
Simply put: housing fundamentals still matter.
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