Iis the current real estate market in a bubble ready to burst? If so, what is the source and extent of the market distortion? The subject of a possible housing bubble has been the subject of discussion lately, especially before Fed officials embarked on the warpath against consumer price index inflation ( CPI). I’ve been asked about this issue and below is a truncated response to all of those queries.
I was asked in 2005 to write a chapter on housing bubbles for a book project on housing economics and government intervention.
Much of the book would cover issues such as government planning, zoning, eminent domain, and various government grants. My chapter would be a “macro” topic unlike the many “micro” topics on housing.
I had been following and writing about the then-current housing bubble (HB1) since 2003, having just left the Alabama Banking Department as Deputy Superintendent of Banking in Alabama to take up a professorship in macroeconomics at Columbus State University in Georgia. .
I have written for LewRockwell.com and mise.org on the housing bubble and in 2005 published my article “Skyscrapers and Business Cycles” in the Quarterly review of Austrian economics who established the general theoretical link between Fed policy and real estate investment and, in this case, the link between Fed policy, record high rises and economic chaos.
Although my chapter was submitted in 2006, it was not published in the planned book until 2009, in the aftermath of the bubble.1
Not only did the editors invite me to include in the final published version elements that they had initially deleted because they were too controversial. They also drew attention to my chapter at the beginning of their introduction to the book:
To the extent that the media was aware of my work, particularly on The Skyscraper Curse, the response and level of appreciation was mixed. On the one hand, CNN was positive, if not surprised, that my work was so precise and specific:
Mark Thornton, an economist at Auburn University, was not surprised by the economic difficulties associated with the inauguration of the Burj Khalifa (renamed Monday from Burj Dubai in honor of the Sheikh of Abu Dhabi, who recently launched a $10 billion lifeline in Dubai).
He predicted tough times for the emirate two years ago in a blog post titled “New Record Skyscraper (and Depression?) in the Making”. He noted that economic depression or stock market crash usually occurs before these skyscrapers are completed.
On the other hand, The Economist I took my “curse of the skyscrapers” model to the test because it didn’t hold up to someone else’s misunderstanding of the data involved. The magazine didn’t actually use my name in their article, although my academic paper was listed in their reference list, although my name was missing there as well.
My letter to their editor was not published and after several months I was extremely surprised to receive an email from them saying that my letter to the editor had been misplaced. Despite its discovery, they did not publish it. Extremely strange?
Here I will review the charts I used in my 2006/09 chapter and update the current housing bubble charts. As you will see, the Fed clearly has not learned its lesson and has put its fingers back in the cookie jar.
Of course, much more could be said about this housing bubble, but I will mention here that the housing bubble is masked by what my friend Kevin Duffy aptly calls the “everything bubble”.2
The first chart is based on the federal funds rate, which is the Fed’s key interest rate. They can control it directly, and because it is the interest rate that banks charge other banks for very short-term loans, it sets the basis for most other interest rates in the economy.
On the far left of the chart, you can see that the Fed has again embarked on a normalizing/tightening phase that is just beginning.
The Fed has yet to raise its target rate above 1%. Balance sheet reductions will be weak until after the November elections. Their response has been particularly anemic so far given that CPI inflation is above 8%.
The 30-year fixed rate mortgage is one of the main drivers of housing bubbles. The 6% rate that caused the previous housing bubble seems high compared to recent years, but 6% is lower at any time since we left the gold standard in 1971.
The truly remarkable rates have only happened in the past few years, when a combination of the Fed cutting its key rate to zero, massive quantitative easing, including massive purchases of mortgage-backed securities ( MBS), and moderate CPI inflation has led to the lowest rates ever, often less than 3%!
The Fed’s verbal war on CPI inflation by its top policymakers threatening deep and sustained rate hikes and huge balance sheet cuts, combined with runaway CPI inflation, has driven rates up sharply market mortgages, now above 5%.
The shift in recent years to fixed rate mortgages and the move away from variable rate mortgages should isolate current incumbents, but could also crush potential buyers and ultimately hurt mortgage investors, banks, Federal Deposit Insurance Corporation (FDIC) and even the Fed itself, which is the biggest investor in mortgages.
If the CPI does not collapse quickly, the Fed will have to raise rates much higher, which would trigger a drop in housing statistics, including prices and new permits – the new housing bubble would burst.
Recently on Bloomberg, a senior Fed official was asked if his policy could reduce house prices and make it more affordable for first-time buyers. The official quickly coughed and said the Fed would never cut home prices, only the rate of increase. I’m glad it’s not my job!
In the twenty years preceding the end of my article, the total amount of real estate loans in commercial banks has increased from $1 trillion to $3 trillion, a massive increase of $2 trillion.
That same number rose from $3 trillion to $5 trillion, another $2 trillion increase over the past fifteen years despite a weak or negative overall market from 2009 to 2015.
The personal savings rate was above 10% on the gold standard and few people were publicly unemployed. Since I left gold in 1971, the savings rate has been declining and was near zero when I finished my chapter in 2006.
It has since risen to a higher level, but remained below the gold standard revenue percentage level, until the covid-19 crisis hit, and the Fed entered its panic response inflationary in March 2020.
The federal government also ran massive deficits combined with multiple rounds of “stimulus” vote buying.
With vast amounts of free money and historic economic uncertainty, the personal savings rate soared to over 25% and has since returned to the previous rate between 5 and 10%.
The money supply as measured by MZM (Zero Maturity Currency) statistics grew 50% during the first housing bubble and has grown another 50% since then, rising in recent years from around $6 trillion to 9 trillion dollars.
Obviously, the Fed is trying to do the impossible, which is to design and imprint the economy towards prosperity, or whatever goal it pursues.
During the previous housing bubble, real private residential fixed investment increased dramatically, almost doubling in the fifteen years before the bubble ended.
During the second housing bubble, it almost doubled again. During the previous housing bubble, I marked the beginning of this bubble by noting that investment in housing even increased during the previous recession.
Investment also rose again during the recent short recession of 2020, which could suggest that the current bubble has not yet reached its final stage.
Another good measure of housing is the number of single-detached housing starts, measured here with data on new private housing units.
This number increased considerably during the fifteen years of the previous bubble, before falling precipitously to an all-time high. Housing starts have followed a similar trajectory since the end of the previous bubble.
Although it has not yet reached the same height as the previous bubble, its absolute increase is about the same and the number of multi-family dwellings has significantly exceeded the previous bubble.
In addition, the number of employees in the construction industry has returned to the record levels recorded during the previous housing bubble.
The amount of household debt rose dramatically during the previous housing bubble and continued to rise for two years after my article ended, before hitting the crash/recession and declining for several years before reigniting and reach new heights.
Since mid-2013, household debt has increased by more than 30% despite the covid-19 crisis which has led to an increase in household savings.
There are a number of alternative explanations for the hot housing and construction sectors, but I have viewed this market as a bubble in the making for many years.
My anticipation is that while this may continue for some time, ultimately we will see that mistakes have been made by the Fed.
Before the latest housing price crash, Fed officials told us that there was no housing bubble, that the Fed had near omniscience and power, and that they would move quickly to prevent a housing bubble or bust. They claim it was their own transparency, but it turns out it was really their deception to us.
Then, on top of that, the Fed gained new powers and authority, Congress passed sweeping regulatory and reporting requirements, while everyone became much more skeptical of house flipping, timeshares and the charms of “housing prices never go down”, and maxims “no one has ever lost money in real estate”.
Now we hear that people are still desperate to buy a home despite sky-high prices. These prices are higher than the asking prices.
That inventory of homes for sale is non-existent in some markets and that available homes are snapped up instantly in other markets.
That buyers are in a catch-22 of rising prices and rising mortgage rates. That recent buyers can return for a profit. To me, these are all echoes of a real estate bubble bursting to its inevitable breaking point.
Source: Mises Institute — Mark Thornton is a senior researcher at the Mises Institute and editor of the book review of the Quarterly review of Austrian economics. He is the author of seven books and is a frequent guest on national radio shows.