Reply to Federal Reserve: signs abound that housing market is entering bubble territory

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[quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous][quote=Anonymous]More data points - This was two days ago.

"[b]Redfin Reports The Share of Sellers Dropping Their Asking Price Is Climbing Past Last Year’s Rate[/b]"

https://www.businesswire.com/news/home/20220407005936/en/Redfin-Reports-Share-Sellers-Dropping-Price-Climbing[/quote]

Yeah that share went up by 3-4 percentage points. If price growth is slowing which you'd expect given interest rates, that makes sense. People list too high all the time, it's just a slightly larger share now. Doesn't mean much else.[/quote]

Lots more data from Redfin pointing toward a slowdown (this was from more than a week ago, and we are in the height of the spring market). https://www.redfin.com/news/housing-market-update-early-signs-of-a-slowdown/

Even Redfin, which has a vested interest in seeing housing prices go up due to its struggling iBuying business, can’t ignore the stats. https://www.marketwatch.com/amp/story/redfin-stock-tanks-after-forecast-shows-losses-expanding-as-ibuying-business-grows-11645134655[/quote]

Sure, but there's a *long* way between what many of these places were predicting for 2022 even a few weeks ago (10-15% appreciation in most cases) and the catastrophic outcomes that people are predicting on this thread. Double-digit prices increased are obviously not sustainable forever, and interest rates have risen more quickly than most expected because the path of anticipated Fed rate hikes and bond sales has gotten more aggressive than expected. The fact that we're seeing a modest but immediate response is frankly good news, and it cuts against the argument that consumers have entered into some sort of irrational bubble mentality. There's nothing to suggest that any response to increased interest rates is anything more than modest right now.

Inflation is problematic for lots of reasons, as are traditional recessions, but the real danger is always from financial crises that cause systemic issues. In that sense, high inflation actually buys the Fed quite a bit of flexibility. They can hit the brakes pretty hard, and inflation-adjusted prices can drop significantly, but as long as nominal prices remain stable, widespread disruption to financial markets remains unlikely. For example, inflation-adjusted home prices could go down in 2022 even if nominal prices go up by 5%! That's a big part of why a large or protracted decline in nominal home prices is unlikely.[/quote]

I didn’t see any catastrophic predictions in this thread. The popping of a bubble is normal and expected (just as recessions are a part of a healthy cycle of economic activity), and it doesn’t have to result in the systemic issues that took down the economy after 2008. But remember, the last housing bubble burst in 2006, two years before the true crisis began. Prices can and will decline regardless of broader systemic issues like risky credit default swaps etc. In 2006, prices declined because the “lack of supply” narrative turned out not to be true, and demand decreased. That was the popping of the bubble. THEN, if prices hadn’t gone down, all those subprime borrowers who couldn’t make their payments could have sold their houses for a profit. Instead, they were underwater. That’s when the foreclosures started, and the rest is history. [Note - I think there are a multitude of ways we could be facing a systemic crisis in the economy soon, but that is another thread entirely.]

And not tracking your first paragraph. Of course the reaction is “modest” right now, it’s only been a few weeks since rates shot up. And there are still buyers who are bidding homes up because they want to lock in low rates. The irrational bubble mentality has changed - the party is over, and the media narrative has shifted from “buy now or be priced out forever” to “sell your house while you can!”

Inflation is a huge problem for the housing market. In an inflationary environment, people face increased costs from all directions and have trouble making ends meet, which can very well lead to people needing to sell or foreclosing. Raising interest rates is a big problem too, because it is likely to lead to recession and job loss, which again leads to selling and/or foreclosing. There really is no good way out and most analysts are not optimistic that the Fed will achieve a “soft landing.”[/quote]

If inflation is so bad for existing homeowners, why was there no foreclosure crisis when interest rates spiked in the early Volcker years? The answer is obvious: in an inflationary environment, homeowners quickly gain positive equity (in nominal dollars), and so they have a strong incentive to sell rather than default. Even though existing home sales dropped precipitously in 1981 and 1982, homeowners were generally able to wait out the interest rate crunch, and so nominal home prices never fell despite massive interest rates and a severe recession.

Why should we not expect the same outcome, or a weaker version of the same outcome? Like the late 1970s, our high inflation is in large part the result of supply side shocks. Unlike in 2008, homeowners are currently already equity rich, and most of their debt is financed at extremely cheap fixed interest rates. Also unlike in 2008, the Fed has a much expanded toolkit that includes simply committing to buy up assets to keep their prices stable. In order for there to be a financial crisis (the only circumstance in which national nominal home prices have ever declined significantly), you need a good explanation for why the Fed would prefer to let one happen than to simply buy its way out. Much moreso than interest rate hikes, asset purchases can have immediate impacts because they involve buying long term debt directly rather than merely pricing market substitutes to long term debt.

I have always found investment bankers to be pretty mediocre when it comes to actually understanding the markets they participate in. Hype beasts and money chasers, not deep thinkers. You appear to be no exception.[/quote]

Trick’s on you because I am not the investment banker. We are in a very different economy than in the 70s and 80s. Houses are much more unaffordable in terms of price to income ratios. But more importantly, housing has become a new asset class for investors and has therefore become much more volatile and does not track inflation. Because so many properties are traded like stocks and crypto, prices are much more sensitive to interest rate hikes. Homeowners can no longer count on prices going up with inflation. Instead, prices are likely to perform much more like all other assets and will start declining as new interest rate hikes take hold. https://reventureconsulting.com/how-hgtv-and-alan-greenspan-created-a-perpetual-housing-bubble/

In 2022, the increase in housing prices is due to a transitory increase in demand, not a fundamental lack of supply (ie numbers of properties out there). See the information discussed upthread re the near instantaneous and steep increase in price after Covid due to low interest rates and high investor participation. The Fed does not have more tools in its tool kit. The Fed funds rate is still near zero so no where to go but up. And in case you missed the news, the Fed has decided to shrink its balance sheet including potentially selling MBS even though no one seems to want to buy them. The Fed has shown it is wiling to throw housing prices under the bus, especially after such a short and steep increase, to protect Americans from rampant inflation. As they should, because your spicy Zestimate is no where near as important as Americans’ need to put food on the table.[/quote]

Ok, so you're not the investment banker. Whatever, your arguments are still poor, as were theirs.

The article you linked to bases everything on a comparison between inflation and home prices. That tells us that real home prices have gone up, which is useful, but it doesn't get anywhere near supporting the argument that housing is some increasingly volatile asset class, bid up by greedy investors high on Property Brothers. Most home purchases are financed, so you need an index that accounts for the cost of capital and increases in real household income over time. The NAR puts out an affordability index that does this, and have done so since the 1970s, although they (annoyingly, predictably) try to charge you for the historical data. However, I found a bunch of the data on an archived HUD website:

https://www.huduser.gov/periodicals/ushmc/winter98/histdat3.html

Compare those index values to the most recent entries using the same index on FRED:

You can see that affordability was actually extremely high by historical standards in the first year of the pandemic, and that it has fallen rapidly in recent months, but that it is still at or above the levels of the 1970s through 1990s. In the early 1980s, housing was in fact far less affordable than it is now for the median household, and yet nominal home prices never fell; inflation just eroded away some of the gains of the 1970s until the market stabilized.

Is it possible that home prices are now more sensitive to interest rates because of the cumulative effect of years of low interest rates? It is; we don't have historical data for that because there is no historical precedent. But nobody, including the markets, expects that we'll be having high interest rates for years. The reason that that yield curve has already started to invert is precisely that investors don't think that these higher interest rates will be sustained. So even in that case, there's no reason we would get anything more than a transitory blip in asset prices.

Also, re: Fed policy, you clearly just don't get it. The Fed has decided to shrink its balance sheet, sure. They can also decide to stop selling assets, or to buy more assets, whenever they want. Current market interest rates have priced in an expected path of repeated funds rate hikes over the next year, and the Fed Board has made its intentions on this very clear. Simply putting a pause to that expected path would cause an immediate drop in interest rates, even if current interest rates are very low, because future hikes would no longer be priced in. So it's just not correct to say that the Fed has no more tools in its tool kit.[/quote]

W/R/T your observations about housing affordability in the 70s/80s, the affordability indexes you are looking at are only based on house price/mortgage rates in relation to income. But it’s much more complicated than that. For example, Americans now have much more debt eating into their incomes, including astronomical amounts of student loans, medical bills, and credit card they are servicing at the same time as their mortgage payments.

As for the Fed’s tool kit, yes you’re right, they can choose to buy and sell assets as they please. But as a practical matter, they don’t really have a choice - they need to unload assets to bring down inflation. That is their mandate, not propping up housing prices. They may choose to do that if inflation is tamed, but we are years away from that. [/quote]

The Fed has a dual mandate to maintain both low unemployment and stable levels of inflation. They're focused on inflation now because unemployment is very low by historical standards, but that doesn't mean that they will only focus on inflation to the exclusion of unemployment if a recession is at hand. Financial crises lead to very high unemployment that magnifies the effects of a normal recession, so it's pretty reasonable to assume that they will go to great lengths to ensure that financial markets remain stable. That doesn't mean that no homeowner will ever lose money, but it does mean that that widespread price declines of any significant size are almost definitely off the table. The Fed would buy assets and choose somewhat higher inflation to avoid a financial crisis and a severe shock to unemployment, in keeping with its dual mandate.

The Fed didn't prevent the financial crisis in 2008 for several reasons. One, the Fed didn't have a clear set of plans for how to react once the zero lower bound on interest rates was hit. There was no rubric for direct asset purchases, for example. Two, the quality of the assets themselves was a serious concern, because of the size of the non-conforming loan market and issues of misrepresentation or fraud in packaged securities. Three, banks were severely undercapitalized relative to the present day, which meant that a spreading financial crisis was simply much harder to contain. I know that people are understandably skeptical of hearing "it's different now," but it really is very different in very tangible ways. And again, outside of a financial crisis, there is essentially no historical evidence of nominal home price declines at a national level other than perhaps a brief blip of a quarter or two.[/quote]

Sure, but the Fed has no mandate with respect to housing prices, except to the extent that it factors into inflation readings. I am not tracking the link you are trying to make between unemployment during a recession and housing prices. You do realize that prices can decline without there being an unemployment crisis, right? There are many things that affect the relationship between supply and demand. Yes, job loss is one of them. But there are many others, especially in this unprecedented period during a pandemic. Obviously we had the Fed pumping the economy with money and keeping interest rates at rock bottom. But other factors caused an increase in demand that are transitory and will fade. For example, there was a demand pull forward of families who had planned to move to the suburbs in a few years but decided to move sooner when the pandemic hit. And there was a huge rush to buy second homes, and that demand has all but evaporated. https://www.redfin.com/news/?p=74151 Likewise, there is a huge batch of new housing in the pipeline.

Remember, the last bubble popped BEFORE the 2008 crisis that led to mass unemployment. Housing prices started going down in 2006. If they had never gone down, the subprime house of cards would never have fallen because people who couldn’t pay their mortgage could have sold for what the house was worth or more.

And yes, we can get into why 2022 is different than 2008. But in both cases, it’s not that the Fed couldn’t prevent the crisis - the Fed created the crisis. The Fed left interest rates too low for too long, which encouraged speculative behavior (including most importantly high investor participation and risk taking by financial institutions). By the time the 2008 bubble popped, the Fed had used all of its traditional tools (ie lowering the Fed funds rate) and literally had to invent QE in order to try to contain the crisis. [b]Now we’re in the opposite pickle since the Fed has to figure out how to get rid of the assets it purchased to fight inflation. Never been done before. No one knows if there will be any buyers.[/b][i][u] [/quote]

This. This. This. This. [/quote]

The Fed actually doesn't even need to find buyers for the assets on its balance sheet, based on their current plan. About 2/3 of what they are planning to eliminate is in the form of Treasury bills. I don't know the exact mix of maturities on those bonds, but apparently they expect to be able to reduce their balance sheet of these by about $60 billion/month simply by letting some of them mature and then not reinvesting the proceeds. The other 1/3 is MBS, and again they are suggesting that they can reduce the balance sheet of these by about $30 billion/month by just letting some of the securities mature. It's referred to as running off or rolling off the balance sheet.

You may believe that they would have trouble selling their MBS if they needed to quicken the pace (I don't), but surely they can sell Treasury bills without any issues, and that's most of what they have.

Some of the numbers (expected rate hikes) in this post are out of date, but I found this overview of the process helpful. The $100 billion/month rolloff cited here is about the same as the $95 billion/month figure that members of the Fed Board have suggested.

https://realeconomy.rsmus.com/how-the-fed-plans-to-use-its-balance-sheet-to-craft-a-soft-landing/

Here is a more detailed overview of the transaction process:

https://libertystreeteconomics.newyorkfed.org/2022/04/the-feds-balance-sheet-runoff-and-the-on-rrp-facility/
[/quote]

It’s not clear that the “roll off” approach will work, or be sufficient. The $95 billion number is just a cap, and it’s not at all clear that the MBS will roll off as fast as they hope (apparently they didn’t in 2017 when they tried this at a much lower level)  A lot of the “roll off” depends on people refinancing and selling homes (mortgages are long term) and that is going to slow down as interest rates rise. It’s already happening.

Its also not clear that the $95 billion will be enough to tame inflation. Remember just 4-5 months ago when we were assured that inflation was “transitory” and wouldn’t reach 1980 levels? Same people.

The Fed has $8 trillion (with a “T”) in MBS and Treasuries on the balance sheet. We are in totally uncharted waters, and if someone is telling you they know how this will play out, they’re lying.

Assume the Fed goes to “Plan B” and can find buyers for the additional securities. That doubles down on removing capital from the market. Banks that are buying securities from the Fed aren’t loaning that money to new borrowers.

https://www.reuters.com/business/what-could-drive-fed-plan-b-balance-sheet-reduction-2022-02-17/

[/quote]

I'm fairly sure that you and I have already had this conversation sometime in the last couple weeks upthread. I'm really not convinced by your argument that the Fed's proposed pace of sales will be insufficient. I agree that if you're correct about that, it would be not great. But, isn't a world in which the Fed can't sell assets as fast as it wants to also a world in which inflation remains higher than long-run targets? How do housing prices decline in such an environment, given that housing is by far the largest component of CPI? A world of high inflation is a world where nominal home prices are continuing to go up.

It seems to me that if you're worried about home prices, the concern you should actually have is that the Fed reduces its balance sheet too quickly, not too slowly. Steepening the yield curve through higher long-run interest rates is the point of the balance sheet reduction in the first place.[/quote]

I think you were talking to me about this, not PP, and I agree with your last paragraph. [/quote]

How are we feeling today? Real estate market crash or prices increasing and last chance to board the train to home ownership?[/quote]

Bump. No takers? Come on, I need to know how to feel today    :shock: [/quote]

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