COVID-19 and the lockdown-induced recession had enormous impacts on the American economy. Beyond the massive increases in federal spending, skyrocketing inflation, delayed supply chains, and unemployment, the shutdowns severely disrupted the housing market — making home ownership even less affordable for the middle class.
Now, the Federal Reserve is warning of a housing bubble as average home prices soar above half a million dollars. Are their fears justified? If so, what could that mean for your family?
Supply and Demand
When COVID-19 hit the United States, the housing market saw a moderate decline in home prices — $383,000 in quarter 1 of 2020 to $374,500 in quarter 2 of 2020, to be exact. By quarter 3, however, prices neared $400,000 and quickly began to rise at a meteoric pace. By quarter 1 of 2022, the average price of a home was $507,800 — a 33% rise in only two years.
One Zillow report revealed that the average American home was only staying on the market for six days during the summer of 2021. In some cities — such as Cincinnati, Kansas City, and Columbus — the typical period on the market was as low as three days.
Many factors contributed to the soaring home prices.
On the supply side, construction of new long-term housing had already been slowing over the past several decades resulting in 6 million too few homes being on the market. Meanwhile, rising costs for lumber, steel, copper, and other raw materials added tens of thousands of dollars to the price for an average new single-family home — all while labor shortages diminished the number of builders and contractors available to work on housing projects.
On the demand side, Americans moved from urban homes to suburban homes — in large part because of COVID-19 lockdowns in major cities. Investment firms such as BlackRock, JPMorgan Chase, and Goldman Sachs also began competing with American families for housing inventory; nearly a quarter of all homes in the United States went to investors during the first three months of 2021.
Perhaps the most salient demand factor, however, was the near-zero interest rate environment that marked the past two years due to the Federal Reserve’s monetary policies.
In an effort to help the United States economy rebound from COVID-19 and the lockdown-induced recession, the Fed implemented aggressive quantitative easing. Virtually overnight, the central bank slashed their target interest rate from 1% to 1.25% down to 0% to 0.25%. The goal of quantitative easing is to manipulate the “federal funds rate” — the interest rate at which private banks can lend to each other overnight. The near-zero federal funds rate caused other interest rates in the economy — such as the bank prime loan rate and three-month CD rate — to plummet.
The reality also extended to mortgage rates, which fell to their lowest levels in modern history. The 30-year fixed mortgage rate dropped from 3.50% at the end of March 2020 to 2.65% by the beginning of 2021, remaining below 3% for most of last year.
At least partially due to quantitative easing, it was therefore far less costly for American home buyers to take out a loan and purchase a house, leading to an increase in the number of homes demanded. The entrance of more would-be buyers into the market increased competition for houses, which in turn caused prices to rise.
But as mortgage rates skyrocket while the Fed reverses its quantitative easing program, the housing market is yet again changing.
Rising Mortgage Rates
As inflation surged to an 8% year-to-year clip, the Federal Reserve voted in March 2022 to raise interest rates by 0.25% — the first such action since 2018, and likely the first of many rate hikes this year.
Mortgage rates had already risen to 3.85% in the first months of 2022. In the wake of the Fed decision, the 30-year fixed mortgage rate soared to 5.11%. According to government-backed mortgage company Freddie Mac, “the combination of rising mortgage rates, elevated home prices and tight inventory are making the pursuit of homeownership the most expensive in a generation.”
In response, many buyers are backing out of the market. “Mortgage application volume continues to decline due to rapidly rising mortgage rates, as financial markets expect significantly tighter monetary policy in the coming months,” economist Joel Kan told CNBC. “As higher rates reduce the incentive to refinance, application volume dropped to its lowest level since the spring of 2019.”
As demand finally appears to be diminishing, the United States housing market finds itself at the precipice of a mountain — and in a position for a spectacular fall, leading Fed analysts now warn of a looming housing bubble.
Bubble Conditions
What is a bubble? As economist Hyman Minsky once famously explained, a “bubble” — sometimes called a “credit cycle” — follows the pattern of displacement, boom, euphoria, profit-taking, and panic. In essence, a surge of funds available for investment leads to inflating asset prices. As more and more investors try to get a piece of the action, smart investors foresee a crash and pull their money out of the market before a massive selloff.
According to economists at the Federal Reserve Bank of Dallas, there is “growing concern” that home prices are “becoming unhinged from fundamentals” — just as they did during the housing crash that sent the world into recession from 2007 to 2009.
“An asset — in this case, housing — is in the primary expansionary phase of a bubble when price rises are out of step with market fundamentals,” the economists described. “Real house prices can diverge from market fundamentals when there is widespread belief that today’s robust price increases will continue. If many buyers share this belief, purchases arising from a ‘fear of missing out’ can drive up prices and heighten expectations of strong house-price gains.”
The analysts place the “exuberance indicator” at the 95% threshold. Statistics such as the house-price-to-rent ratio and the house-price-to-disposable-income ratio are soaring — indicating abnormal housing market behavior “for the first time since the boom of the early 2000s” and house prices that “appear increasingly out of step with fundamentals.”
Beyond historically low interest rates, the economists point to government stimulus, as well as supply chain disruptions and their associated policy responses.
Fortunately — because excessive borrowing is not the driver of this particular housing boom — any crash may not be as spectacular as the one that upended the global economy 15 years ago. However — in a post-COVID world gripped by countless economic troubles — the crash will by no means be pretty.
The views expressed in this opinion piece are the author’s own and do not necessarily represent those of The Daily Wire.