Federal Reserve Bank of Dallas Signals Caution and Housing Expert Rebuttal

Recent Pandemic is Source of Daunting Real Estate Bubble 

Several weeks ago, the Dallas Federal Reserve Bank penned a research paper highlighting the rapid increase in house prices that took effect during the pandemic and warned that a heightened level of “exuberance” could be working its way into certain housing markets across the country and across the world as house prices show signs of becoming “unhinged” from fundamentals. The paper specifies several actions in the market which are likely contributors to the recent rise in house prices, including “shifts in disposable income, the cost of credit and access to it, supply disruptions, and rising labor and raw materials costs”. As in the case of a classic bubble scenario, fundamentals can temporarily become misaligned with prices leading buyers to believe that prices may soon become out of reach and causing a “fear of missing out” or FOMO environment which can perpetuate the misalignment in prices.

Data Series Helps to Alleviate Pandemonium  

The Fed paper points to an acceleration in house prices starting in 2020 which exhibits signs of exuberance. The data shows that starting in early 2020, actual US house-price-to-rent ratios began to deviate from fundamental price-to-rent ratios, raising warning signs that prices were becoming overextended. A second data series, US price-to-income ratio was also studied and while this ratio has risen over recent quarters, it was not deemed to be in exuberance territory. The authors prefaced that price-to-income data could have been temporarily distorted by pandemic related fiscal and monetary stimulus efforts and thus potentially turn out to be transitory. The Fed paper concludes that while conditions in the US housing market warrant observation, there is no expectation that fallout from a housing correction would be comparable to the 2007-09 global financial crisis in terms of magnitude and economic fallout. They note that household balance sheets appear to be healthier today and that home purchases are not being fueled by excessive borrowing. ¹

Housing Expert Explains the Positives

In a follow-up article on housing published by Fortune Magazine, housing expert Edward Pinto of the American Enterprise Institute Housing Center articulated a rebuttal to the Dallas Fed paper. Mr. Pinto is more positive on the US housing market than the economists at the Dallas Fed for several reasons. He states that the driving force behind house price appreciation today is not “wild speculation” but a whole new set of dynamics including relatively favorable mortgage rates, record low inventories, modest household leverage and baby boomer reluctance to downsize as they age. The biggest difference of all is the pandemic derived phenomenon of remote work as a real option for a large swath of the workforce. Remote work has given families the ability to leave high-cost metros on the coasts and relocate to more affordable sunbelt cities in what Pinto calls the “great housing arbitrage”. Mr. Pinto is predicting that house prices will continue to appreciate at a rapid pace in 2022 and into 2023. Another reason for Pinto's bullishness is inflation. He argues that owning a home can be a good hedge during inflationary periods and also borrowing at relatively attractive mortgage rates of 5% when inflation is over 8% implies “real” or inflation-adjusted mortgage rates are less than zero. Finally, Pinto touches on the supply of housing and notes that the volume of homes for sale stands at a 50-year low. The inventory of 890,000 family units is around one-third the figure of 2.5 million in 2006 and half the level of one year ago. He also notes that new construction is lagging sales by a wide margin. ²

Footnotes:

¹Dallas Fed Economics: Real-Time Market Monitoring Finds Signs of Brewing U.S. Housing Bubble; March 29, 2022
By Jarod Coulter Valerie Grossman, Enrique Martinez-Garcia, Peter C.B. Phillips and Shuping Shi

²AEI Housing Center – Ed Pinto Blog post; April 15, 2022

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