The skyrocketing price of housing has been among the biggest storylines of the post-pandemic economy.
According to new research from the Dallas Federal Reserve, more than $9 trillion of wealth in the housing market was created from the start of 2020 to the second quarter of 2022 – almost all of which comes from appreciation.
It’s only in recent months, as the Federal Reserve has raised interest rates and inflation has continued to stay elevated, that this growth has slowed.
As for what this means in the long run, that’s still unclear – but author of the Dallas Fed’s research Enrique Martínez-García joined the Texas Standard to explain some of the developments in the housing market and what might lie ahead. Listen to the story above or read the transcript below.
This transcript has been edited lightly for clarity:
Texas Standard: One word you used to describe the current state of the housing market is “frothy.” Could you explain what you mean by that?
Enrique Martínez-García: Absolutely. So the reality is that a lot of things were happening at the beginning of the pandemic and the market was already fairly robust coming into the pandemic. But since then, we have seen clear signs and markers of expectations driven by the type of acceleration in house prices that we saw over the past two and a half years is rather inconsistent with the behavior of the standard fundamentals, like the changes in income or mortgage rates. But on the other hand, it is very much consistent. It is what you would expect to see in scenarios where a lot of people are getting into the market, searching for yield, expecting that future gains are going to be just as robust, if not more than they were in the past.
You know, what you’re describing includes some of the basic recipes for a bubble. And it seems like the premise of a lot of your research here is that the massive price increases “poses an outsize risk for the U.S. economy.” What’s the problem as you see it?
The problem is we’ve seen this very large run up in house prices. We also have seen a very quick turnaround in monetary policy since March of this year. Mortgage rates went from about three, three and a quarter in 2021 to near 7% right now – so a very large mortgage rate increase, something that we haven’t seen in a generation. Just to give you an idea, by the way, mortgages are about 20 to 25% of what they were at the peak of the boom in 2020-2021. So, a huge fall in mortgage origination that we are already seeing. Yes, this may have a severe effect on the economy, not necessarily like in the previous housing crisis since the fundamentals of households and banks, at least on average, seem to be better than they were back then. And the lending standards are stronger. But it can nonetheless lead to a much significant correction in house prices than we are currently anticipating, and that can have a negative wealth effect.
You have fewer people who are able to afford houses with interest rates where they have risen to now. But you go on to say this could aggravate an economic downturn. How bad could it get? I mean, we all remember the housing bubble in 2008. We’re looking at something like the Great Recession?
The way I will frame it is like this: What would it take for the housing market by itself to bring the U.S. economy into recession territory? By some estimates, a correction of about 15 to 20% in house prices would do the trick. That has a knock on effects on consumption and investment. And we are already anticipating without that significant correction in house prices, that 2023 is going to be a rather weak year in terms of growth, with growth below trend of about 1%. So it doesn’t take too much to actually push us into recession territory and to get unemployment rising as well.
What you’re describing, the potential for an economic downturn seems very scary. What would you say to those considering buying or selling right now?
I would say that I am not in a position to give advice to those buying. But nonetheless, I think it would be safe to exercise caution in this environment because mortgage rates and the housing market are getting into uncharted waters.