Dallas Federal Reserve warns of potential housing market crash

by mcardinal

Lauren Moye, FISM News


Home prices soared nearly 20% from January 2021 to January 2022. Meanwhile, mortgage rates recently rose to their highest levels since 2018. As home sales drop amid what realtors have still termed a competitive market, the Federal Reserve Bank of Dallas has warned of “signs of a brewing U.S. housing market bubble.”

The bank explained that the “rapid real house-price appreciation” could be caused by real economic factors such as more disposable income, supply disruptions, and rising costs. However, they added, “But real house prices can diverge from market fundamentals when there is widespread belief that today’s robust price increases will continue.”

It’s this divergence that leads to an inflated bubble that will eventually pop, as homeowners witnessed in 2006 when the market crashed. The factors that might lead to another market bubble differ from that one. However, home purchases made in the hopes of catching the low-end of a future value increase can drive up prices and “heighten expectations of strong house-price gains,” the federal reserve said.

Realtor.com reported on the huge surge in year-over-year home prices with various indexes. The lowest increase came from the Federal Housing Finance Authority (FHFA), which calculated an 18.2% increase in home prices between January 2021 and January 2022. The highest report came from the Case-Shiller national home price index, which showed a 19.2% rise during the same period.

A highly competitive market, due in part to low mortgage rates at the time, is partially responsible for driving up home values. Now that mortgage rates have risen to a current average of 4.67%, the housing market is anticipated to respond.

Realtor.com economic research manager George Ratiu said, “With mortgage rates moving toward 5%, we are seeing early signs of a shift in housing fundamentals, as many people looking for a home have hit a ceiling on their ability to afford a home.”

Home sales have already been declining with a 4.1% decrease in February compared to the month before. That makes the fourth consecutive month for a dip in home sales. However, prices remain high and some economists fear this will lead to an artificially high market.

“The mortgage rate shift has not dampened upward price pressure from intense borrower demand and limited supply,” Will Doerner, a supervisory economist in the FHFA’s division of research and statistics, said in the agency’s report.

At the Dallas Fed, economists have been monitoring the housing market for signs of a “market tipping point.” One sign they searched for is an “exuberance” factor, where prices outpaced “what economic fundamentals would justify.”

“The current reading indicates that the U.S. housing market has been showing signs of exuberance for more than five consecutive quarters through third quarter 2021,” the Dallas Fed reported.

They also noted signs of exuberance when comparing U.S. price-to-rent ratio, which graphs the amount of monthly rent compared to the house’s price. The Dallas Fed noted this was “comparable to the run-up of the last housing boom.”

Finally, they examined the ratio of disposable income compared to the home value. While they did not find exuberance levels in this area, they did warn that the “rapid increase” their charts show hints that “U.S. real house prices may soon become untethered from personal disposable income per capita.”

The Dallas Fed concluded, “Our evidence points to abnormal U.S. housing market behavior for the first time since the boom of the early 2000s.” However, they would not expect the market fallout to reach the crisis level of the recession caused by the market collapse of that time.