The Federal Reserve pours billions of dollars every month into the mortgage market. Home prices have skyrocketed beyond affordability for some would-be buyers. How much blame should we pin on the Fed?
It turns out that you can't answer that question with the specificity I hoped for. Yes, the Fed is partly responsible for rapidly rising house prices, but other factors are at play, too. Along the journey to my vague answer, we’ll encounter cramped houses, an oddly precise number and a reference to a serpent's anatomy.
What the Fed did and why
On March 15, 2020, the Fed flooded the banking system with money to cushion the COVID-19 recession. The central bank cut a key short-term interest rate to near 0%. And it committed to buying hundreds of billions of dollars of government and mortgage debt that were "central to the flow of credit to households and businesses." Since December, it has been buying at least $80 billion in government bonds and $40 billion in new mortgage debt each month.
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Mortgage rates tumbled after the Fed's announcement. The 30-year fixed-rate mortgage dropped almost half a percentage point within a month. Then it kept falling. In September it slipped below 3% APR and has stayed there most of the time since.
Prices shoot the moon
As mortgage rates plummeted last summer, home prices blasted off. They remain aloft. In July 2021, the median price of an existing home was $359,900 — 17.8% higher than 12 months before, according to the National Association of Realtors.
That brings us to the $40 billion the Fed is adding to the mortgage market every month. The money pushes mortgage rates lower, which brings in more buyers, who compete with one another by bidding up prices. Is the Fed's market intervention driving rapid increases in home prices?
I pulled out a calculator. The Fed pumped $40 billion into the mortgage market in July, and people bought 647,000 new and used homes that month. If you divide $40 billion by 647,000 homes, the result is a little over $60,000 per home. Did the Fed inflate house prices by that amount?
Economists assured me that it's more complicated than that.
"Suppose [Fed Chairman Jerome] Powell had just bought Treasury bonds" and not mortgage debt, says Dean Baker, senior economist for the Center for Economic and Policy Research. "We'd see largely the same story."
Yelena Maleyev, economist for Grant Thornton, an accounting and advisory firm, says: "When we look at the rapid increase in house prices, underneath it we're looking at the significant undersupply of homes for sale."
Indeed, for-sale homes have been scarce. At the rate homes were purchased in July, it would take 2.6 months to sell out. A 2.6-month supply is lower than a snake's belly and signals a dire shortage. When supply is scarce, prices go up.
There's some more in this house
This is all pretty clear so far, but hang on because it's about to get murky. The intersection of the Fed's monetary policy, mortgage rates and COVID-inspired social distancing makes this whole thing too complicated to pin blame on a single factor.
As rates were falling in 2020, offices and schools were shutting down. Cubicle dwellers worked from kitchen tables. Scholars from kindergarten to college attended school from home. Formerly comfy houses now felt crowded and loud. As cooped-up families "zillowed" for roomier digs, they were delighted to find mortgage rates near record lows.
That's when would-be buyers discovered they had competition. Not enough homes were for sale to meet the demand.
Elliot Anenberg and Daniel Ringo, economists in the Fed's real estate finance section, wondered which was a bigger factor in the housing shortage: high demand from people looking for more space or restricted supply because people didn't want to sell their homes during a pandemic?
In a research note titled "Housing Market Tightness During COVID-19: Increased Demand or Reduced Supply?," they concluded that "93 percent of the decrease in months' supply to date is driven by higher demand." (That's the oddly precise number mentioned earlier.) Reduced supply was but a minor factor.
Baker agrees that a surge of buyers is behind rising home prices. "You're lowering interest rates, and as a result of that, of course housing is more affordable,'' he says. "That's the point, and that's causing more demand for housing and pushing up prices."
It's easy for the Fed to take the fall
House prices are skyrocketing for multiple reasons. There is no quick remedy for the shortage of homes, and you can't stop people from clamoring for more space. But Federal Reserve monetary policy can be adjusted in a video conference, with mortgage rates soon following. So the Fed is the policy lever that people grasp for.
James Bullard, president of the St. Louis Federal Reserve Bank, said in an interview that rapidly rising home prices are "freezing out new home buyers and home buyers that might be at the lower end of the income distribution." He urged the central bank to start scaling back on purchases of government and mortgage debt in September. Other Fed members joined the chorus.
Chairman Powell isn't in as much of a hurry, saying after the most recent monetary policy meeting that "we have some ground to cover on the labor market side" before reducing debt purchases.
The Fed probably will take that initial step in late 2021 or early 2022. Mortgage rates almost surely will rise, and higher rates will reduce demand for houses because of the impact on affordability.
Higher mortgage rates will disproportionately harm the people who Bullard wants to help: first-time home buyers and people who don't earn a bundle. But plenty of high-earning people still will be looking for more room.