Many longtime readers know that I have been very criticism of the housing market after the massive boom in post-COVID house prices.
And as we learned from the underrated Austrian economist – Ludwig Von Mises – the larger the arrow; the larger the bust.
So – after a extraordinary Housing Market Rise Post 2020 – I think the housing market is more fragile than many realize as market liquidity disappears. And will have far-reaching ripple effects throughout the economy.
Let me explain. . .
There are of them main reasons for this recent real estate boom.
And that’s greater housing demand spurred by Federal Reserve easing. And the decline in supply due to the decrease in housing construction and government policies.
This combination of increased demand and declining supply is the background for the price increase.
And over the past twenty plus years, this correlation has proven to be true.
Just take a look at the chart showing the difference between the evolution of housing prices and the monthly supply of housing on the market. . .
So, the surge in prices after 2020 should come as no surprise.
Why?
Because the Fed artificially boosted demand upper – by lowering interest rates, buying mortgage-backed securities (MBS), etc. braked supply – by restricting the construction of houses, suspending mortgage payments, suspending foreclosures, etc.
And although many of these problems have created strict distortions in an already tight housing market over the years (especially the construction of houses restriction in major cities that have kept prices artificially high). I think the Fed’s purchase of mortgage bonds was the most incendiary.
That’s because the Fed’s short-sighted policy of buying MBS poured gas into an already hot housing market.
To put this into context: the Fed bought over $1.5 trillion mortgage bonds within two years of the onset of COVID. Now MBS makeup roughly a third from the fed entire balance sheet.
The Fed bought all those mortgage bonds and kept them on its balance sheet to provide liquidity and prevent falling house prices. (Meaning: the Fed’s purchase of mortgage bonds stimulated excess demand that would not have existed in the free market).
But this is not something new. . .
The Fed first started buying MBS after 2008 in an attempt to keep house prices from falling further.
And since then they have only bought After and After after every slight drop in prices. . .
So, to recap: post-COVID artificial demand and weakening supply has created a huge housing boom.
But now – since the start of 2022 – the Fed is tightening financial conditions with rate hikes. And has stopped buy mortgage bonds. And instead started leaving these mortgage bonds on their books expire or be resold in the private sector. (Thereby raising prices and sucking capital out of the financial system).
The big problem now is that after inflating such a huge housing bubble – the current Fed tightening cycle is deflating the housing market.
For example, house prices plunged 1.5% month-to-month between July and August. A decline that had not occurred since 2009.
The housing market is starting to – ultimately – feeling the effects of the Fed rate hikes (which pushed the 30-year fixed mortgage rate above 7% – this is The highest in addition to 20 years).
But for perspective – even with momentum turning downwards – prices are still significantly higher in annual terms (more than 12%).
That’s how hot the housing market was.
Still, it’s important to keep in mind that housing prices (especially on the West Coast) are falling rapidly.
For example: from roughly 900 U.S. regional real estate markets in the Zillow Home Value Index (ZHVI) – over 120 have seen home prices declines during the last 3 month period. And of those, 20 markets have seen house prices fall by more than 5%.
And it’s not just buyers who are hesitating due to soaring rates and falling prices.
Sellers no longer enter the market.
Recent data – according to National Association of Realtors – showed that pending home sales fell for Fourth months in a row. Decrease of more than 10% between August and September.
And all four major US regions saw declines from a year ago.
Clearly, the US housing market is becoming more fragile as liquidity (buyers and sellers) dwindles. And quick.
Meanwhile, the Fed continues its tightening trajectory. Increase this disadvantage.
This will have serious repercussions on many people and on the economy.
For example – the post-2020 boom has seen US household wealth explode in a context of rising asset values (most of which are stocks and real estate). Reaching a record level at the end of 2021.
But since then – as asset prices fall in 2022 – US household wealth has fallen by one registration $6.1 trillion (5.2%) in the second quarter.
And that marks the second consecutive quarterly decline.
The main reason for this decline in wealth was due to the massive $7.7 trillion drop in stock value over the past few months.
Meanwhile, real estate prices increase $1.4 trillion over the same period. Help offset the decline in household wealth.
But, as always, house prices come with a lag effect (i.e. it takes some time after Fed tightening to see negative impacts; and vice versa).
And now, more than ten months into this aggressive tightening cycle – we are starting to see real estate prices weaken.
Remember: as an infamous macro investor – George Soros – taught; markets are reflexive. This means that human expectations and biases and feedback loops amplify boom and bust cycles. As rising prices can lead to more speculative buying and therefore higher prices. But also that lower prices can lead to new sales and lower prices. Etc.
I imagine this lower reflexive loop for assets will put further pressure on household wealth and homeowners as the Fed continues to tighten. This could lead to further price drops as marginal homeowners wish to sell their properties. Compounding the inconvenience.
Either way, the momentum is clearly to the downside as long as the Fed continues to tighten. . .
So, in summary, I believe the weakness in the housing market is likely to continue for the foreseeable future. Most likely until the end of 2023 due to the lag effects of Fed tightening.
House prices have been several times higher than “real” (after inflation) wages for decades. This means more and more debt is needed to keep buyers buying.
And I don’t expect buyers to easily accept higher debt costs resulting from Fed rate hikes.
Now – I am aware that there is still a deep housing shortage this keeps prices artificially high (thanks to incompetent government policies). There is also a large flow of money which institutional investors use to pick up houses as discounts appear. Thus help prices.
But still, it remains to be seen whether these two major factors will prevent further declines in house prices.
And until it is otherwise – I expect further housing fragility in 2023.
You must beware.