Soaring house prices have become one of the main storylines of the post-pandemic economy.
According to new research The Dallas Federal Reserve created over $9 trillion worth of housing market fortune from early 2020 to Q2 2022, almost all of it through appreciation.
Only in recent months, as the Federal Reserve raised interest rates and inflation continued to be high, did this growth slow down.
What this means in the long run is not yet clear, but Dallas Federal Reserve Bank study author Enrique Martinez-Garcia joined the Texas Standard to explain some of the developments in the housing market and what could happen ahead. Listen to the story above or read the transcript below.
This transcript has been lightly edited for clarity:
Texas Standard: One word you’ve used to describe the current state of the housing market is “foamy.” Could you clarify what you mean?
Enrique Martinez-Garcia: Absolutely. So the reality is that there was a lot going on at the start of the pandemic, and the market was already pretty resilient to the pandemic. But since then, we have seen clear signs and markers of expectations driven by the type of house price acceleration we have seen over the past two and a half years that is rather inconsistent with the behavior of standard fundamentals such as changes in income or mortgage rates. But on the other hand, it’s very consistent. This is what you would expect to see in scenarios where a lot of people enter the market looking for profitability, expecting future profits to be the same, if not more, than they have been in the past.
You know, what you describe includes some of the basic bubble recipes. And it seems that the premise of much of your research here is that massive price increases “pose an excessive risk to the US economy.” What is the problem, how do you see it?
The problem is that we are seeing a very large jump in house prices. We have also seen a very rapid turnaround in monetary policy since March of this year. Mortgage rates have risen from about three, three and a quarter in 2021 to almost 7% right now – so that’s a very large rise in mortgage rates that we haven’t seen in a generation. By the way, to give you an idea, mortgages are about 20-25% of what they were at the peak of the boom in 2020-2021. So, the huge drop in mortgage lending that we’re already seeing. Yes, this could have a major impact on the economy, not necessarily like the previous housing crisis, as the fundamentals of households and banks, at least on average, seem to be better than they were then. And lending standards are stronger. However, this could lead to a much larger correction in house prices than we currently expect, and this could have a negative impact on welfare.
You have fewer people who can afford houses with interest rates where they have now grown. But you keep saying it could exacerbate the economic downturn. How bad can it be? I mean, we all remember the housing bubble in 2008. Are we looking at something like the Great Recession?
I’ll put it this way: what does it take for the housing market to drive the US economy into recession on its own? By some estimates, a house price correction of around 15-20% could help. This has an impact on consumption and investment. And we already expect, without this major correction in house prices, that 2023 will be quite weak in terms of growth, with about 1% below-trend growth. So it doesn’t take too much to actually push us into a recession and also cause unemployment to rise.
What you are describing, the potential for an economic downturn, seems very frightening. What would you say to those who are considering buying or selling right now?
I would say that I am not in a position to give advice to those who buy. But still, I think it would be safe to be cautious in this environment, because mortgage rates and the housing market are heading into uncharted waters.