Housing is not in a bubble
A decade of disinvestment is causing affordability issues, not rampant speculation.
Suggestions that housing is in a bubble and the Fed’s ultra-dovish policies are the cause don’t exactly mesh with reality. For one, it’s a stretch to think of housing being in a bubble when the biggest problem is its dearth of supply. As for the Fed, its simple goal of keeping rates low to reduce debt service costs for businesses and consumers has helped spur a broad and robust recovery, including in housing. As builder and buyer access to low-rate construction and mortgage loans continues, both sides of housing’s supply (builders) and demand (buyers) equation are benefitting. It’s a dynamic that looks to keep going, with the Fed firmly committed to low rates and structural forces (rising household formation rates, a pandemic-fed desire for larger homes among them) underpinning housing demand.
Housing does have an affordability problem, no question. And the Fed arguably has played a role. Just as discounting future cash flows at a lower rate increases an asset price, ultra-low mortgage rates tend to contribute to higher home prices. For borrowers, it’s all about the monthly payment. But larger forces appear to be at work on the pricing front, led by a housing up-cycle that started with a severe shortage of inventory—an overhang from the 2007-09 Global Financial Crisis whose foundations were built around a housing boom that went horribly bust. Residential investment plunged and remain subdued for 10 years, with housing starts plummeting 79% from the past cycle’s January 2006 high to its April 2009 low. Despite steadily climbing since, starts are still 23% below January 2006 levels, leaving the U.S. housing market 3.8 million single-family homes short of what’s needed to meet demand, according to Freddie Mac. Hardly an environment that fosters widespread overbuilding and financial speculation.
For builders, pricier homes are where the payback is
Restrictive local zoning and land-use policies and declining household formation rates for much of the past decade have discouraged new supply, too. More recently, lumber and labor shortages—blame pandemic-related disruptions and a decade of residential disinvestment—have caused input prices to soar, putting further upward pressure on home prices. One last factor: an understandable desire by builders to construct pricier homes where the margins are wider, helping them to cover these rising costs and still make a tidy profit. Add all these factors together, and the result is record high prices, according to the Federal Housing Finance Agency’s (FHFA) monthly index of home prices. The S&P CoreLogic Case-Shiller home-price gauge posted its biggest year-over-year gain in 15 years in February alone.
The elevated prices are keeping some moderate-to-lower income buyers out of the market, worsening wealth disparities. The Mortgage Bankers Association says credit availability—a measure of lenders’ willingness to issue mortgages—is near its lowest level since 2014. In the refinancing end of the market, the Wall Street Journal reports the share of Fannie Mae refinancings for borrowers with credit scores below 700 plunged from almost 30% in January 2019 to 9.4% this past January. The FHFA is launching a new program for lower-income homeowners who missed out on the past year’s refinancing boom, with a goal of helping them still lock in historically low interest rates, in part by easing credit requirements, simplifying documentation and waiving certain fees.
Fed’s message: spreads are likely to remain extremely tight
In last week’s press conference after its policy-setting meeting, Fed Chair Powell said the hope is over time, builders will replenish housing supply. This may be the best way to restrain price increases and boost affordability. But he also said policymakers aren’t seeing bad loans, unsustainable prices and other characteristic of past crises that would raise “financial stability concerns” about today’s housing market. Powell also reiterated the Fed isn’t thinking about tapering monthly $120 billion purchases of agency mortgage-backed securities (MBS) and Treasuries, meaning rates should stay low and spreads—the yield differential relative to comparable maturity Treasuries—in residential MBS and most bond sectors should remain extremely tight. This limits potential upside but a positive offset for residential MBS is the healthy underlying market of rising prices, strong demand, tight supply … and no bubbles.