Federal Reserve Warns of an Emerging Housing Bubble

Thursday, March 31, 2022

GoLocalProv Business Team

 

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Federal Reserve issues its strongest warning to date about a housing bubble PHOTO: file

The Federal Reserve is warning that the American housing market may be headed for a bubble.

The warning issued by the Federal Reserve Bank of Dallas on Tuesday states, “Real house prices—prices adjusted for inflation—have steadily increased in the U.S. since 2012. Further acceleration in the pace of house-price appreciation began before the pandemic but has strengthened noticeably since early 2020.”

The Fed says that this crisis is different than the issues relating to "The Great Recession, stating they "argue that the underlying causes of the run-up differ from those during the last housing boom, which preceded the 2007–09 Global Financial Crisis. However, there is growing concern that U.S. house prices are again becoming unhinged from fundamentals.”

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In Rhode Island, the median price of February’s single-family home sales increased 15% to $368,000. And, the RI Association of Realtors reported that in February there was a record low level of inventory.

With home prices at record highs and inventory at record lows, nearly two-thirds of non-homeowners (64%) say an affordability factor is holding them back from owning a home, according to a new Bankrate.com report issued Wednesday. "This includes 43% who say their income levels are not high enough, 39% who think home prices are too high, and 36% who can’t afford a down payment and/or closing costs (respondents could select more than one factor). Additionally, 58% of all U.S. adults would be willing to take action to find more affordable housing," according to Bankrate.

The Fed warns that the fundamentals are broken and the market has become “misaligned” from economic realities.

 

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Record low inventory in RI continues to push prices higher PHOTO: GoLocal

Monitoring Emergence of Housing Bubbles in Real-Time

"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. Rapid real house-price appreciation, such as that observed now, does not in itself signal a bubble. Shifts in disposable income, the cost of credit and access to it, supply disruptions, and rising labor and raw construction materials costs are among the economic reasons for sustained real house-price gains," states the Fed.

"But 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," add the Fed.

The demand continues to substantially outpace supply in Rhode Island. With just 789 single-family homes for sale last month, the supply reached a record-breaking low since 1998, the year the RI Association of Realtors began keeping inventory records. The number of single-family homes for sale fell 30.6% from February 2021, and 67.6% from 2020, just before the pandemic began.

 

The Fed Identifies a number of critical issues:

- The gap between the actual price-to-rent ratio and its fundamental-based level in the U.S. has grown rapidly during the pandemic—comparable to the run-up of the last housing boom—and started showing signs of exuberance in 2021. The exuberance statistic confirms that recent increases are far from ordinary.

- Another important long-run anchor—tied directly to housing affordability—is the ratio of house prices to disposable income...U.S. real house prices may soon become untethered from personal disposable income per capita.

- Evidence points to abnormal U.S. housing market behavior for the first time since the boom of the early 2000s. Reasons for concern are clear in certain economic indicators—the price-to-rent ratio, in particular, and the price-to-income ratio—which show signs that 2021 house prices appear increasingly out of step with fundamentals.

- The surge in disposable income is mostly associated with pandemic-related fiscal and monetary stimulus efforts and reduced household consumption arising from mobility restrictions and lockdowns.

- If disposable income increases turn out to be transitory—as fiscal stimulus wanes and the Federal Reserve reverses its accommodative monetary policy—recent patterns in the price-to-income ratio may prove a less-useful measure of housing affordability. Such transitory increases in disposable income are not strong determinants of long-term housing investment. Thus, the price-to-income ratio measure alone may produce overly conservative results when identifying housing market bubbles.

 

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Concerns about amount of household income spent on housing PHOTO: File

Is Another U.S. Housing Bubble Brewing?

While the Fed warns that a real estate "bubble" is brewing, they saw the financial system is better suited to handle it.

"Our evidence points to abnormal U.S. housing market behavior for the first time since the boom of the early 2000s. Reasons for concern are clear in certain economic indicators—the price-to-rent ratio, in particular, and the price-to-income ratio—which show signs that 2021 house prices appear increasingly out of step with fundamentals," said the Fed.

"While historically low-interest rates are a factor, they do not fully explain housing market developments. Other drivers have played a role, including pandemic-related U.S. fiscal stimulus programs and COVID-19-related supply-chain disruptions and associated policy responses. The resulting fundamental-driven higher house prices may have fueled a fear-of-missing-out wave of exuberance involving new investors and more aggressive speculation among existing investors," it adds.

"Based on present evidence, there is no expectation that fallout from a housing correction would be comparable to the 2007–09 Global Financial Crisis in terms of magnitude or macroeconomic gravity. Among other things, household balance sheets appear in better shape, and excessive borrowing doesn’t appear to be fueling the housing market boom," the Fed said.

 

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