Sunday, February 20, 2022

Will The Fed Crush The Housing Market Again? Will 2022 Rhyme With 2007 Due To Interest Rate Increases

One of the dumbest things I've heard is the statement that "no one saw the 2008 financial crisis coming". Typical is Paul Krugman's comment  that the crisis “came as a shock to me as to almost everyone”. Well, if you've seen the movie "The Big Short", it's obvious that a coterie of smart investors forecast the crisis and profitted off it. Further, lots of folks in the real estate, housing, and mortgage businesses saw it coming. Personally, during the 12 consecutive times in 2005 and 2006 that Greenspan and Bernake's Federal Reserve raised the Fed Funds rate, I cursed them for their stupidity. It should not have been a surprise that they crashed the housing market.

There are certainly some significant differences between 2007 and 2022. 

1) Currently, the Fed Funds rate is only 0.25%. During 2005-2006, the Federal Reserve raised the Fed Funds rate from 2.5% to 5.25%. 

2) In 2007, if someone could fog up a mirror, they could get a mortgage. Lending standards have tightened up since then. A decline in housing prices will be unlikely to generate as many loan defaults. During the financial crisis, loan default foreclosures became a vicious cycle in exacerbating housing price declines 

3) The speculative buying of homes has moved from individuals to corporations. Hopefully, the corporations buying up homes in today's market will be better able to manage a drop in housing prices and won't be forced to sell into a declining market. 

In 2006, home builders realized that too high a percentage of the homes in their housing developments were being bought by individual investors as rental properties. In addition to the financial risk of mortgage defaults, too many rental properties in a neighborhood of single-family homes can cause property prices to stagnate or drop. That's because tenants don't maintain homes to the level that owners who actually live in the property do. Unfortunately for home builders, most were a bit late to realize the risks of selling too many homes to retail investors utilizing mortgages to borrow money.

Thus, there are too many differences in today's conditions for history to repeat itself (but it may rhyme, to paraphrase Mark Twain). And if we get another Fed driven steep increase in interest rates, it will bleed into the cost of new mortgages. At the nosebleed level of the residential housing market, it won't take too significant an increase to mortgage rates to crush the housing market.

According to this January 10th CNBC article "The current jump in rates will cost potential homebuyers dearly. For a median-priced home, currently about $350,000, buyers putting down 20% will now see a monthly payment $125 higher than they would have just three weeks ago. For those using low down payment loans, the monthly increase will be even larger. Higher interest rates could throw some cold water on high home prices, as buyers hit an affordability wall." And the $125 figure is already badly out of date as mortgate rates have gone up about half a percent since then.

The Federal Reserve hasn't even started the upcoming series of interest rate hikes, and the 30 mortgage rate has already increased from under 3% to over 4%. If the Federal Reserve actually does increase the Fed Funds rate 7 times, as some are predicting, it was crush the housing market again.

If we do get a Fed Funds induced sharp drop in housing prices, beware of the impact upon the economy and the stock market. Dropping housing pricing adversely affects consumer confidence and perception of personal wealth. It also leads to a decrease in  construction employment. Thus, lower economic growth becomes likely and a declining housing market can be a major contributor to an economic recession. 



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