The Housing Bubble Popped, and the Fed Can Let it Rip

November 8, 2022

Raging inflation knocked out the “Fed put,” and banks are no longer on the hook for mortgages; taxpayers and investors are.

By Wolf Richter. This is the transcript of my podcast on Sunday, Oct 30, THE WOLF STREET REPORT.

So we have a weird situation. Not weird actually. Just reality. After mind-boggling ridiculous spikes, home prices in most markets are dropping, and in some markets, they’re plunging at the fastest pace on record. And in some markets, they’re going down faster than they’d spiked on the way up. And it’s just the beginning. There is nothing magic about this.

The average 30-year fixed mortgage rate has more than doubled since last year, from less than 3%, to now over 7%, the highest in 20 years, the highest since 2002. But there’s a difference between 2002 and now: The magnitude of the home prices.

Home prices have shot up to ridiculous highs in the era of interest rate repression and money printing by the Federal Reserve. But that era ended earlier this year. Now we have surging interest rates and the opposite of money printing: quantitative tightening.

So now we’ve got sky-high home prices, and I mean ridiculous home prices, and mortgage rates that were normal when home prices were just a fraction of today’s prices.

Over the past two years, we’ve seen spikes of home prices of 30% to 60%. In the Miami metro and the Tampa metro, for example, home prices spiked by 60% in two years, according to the Case-Shiller index. Which is just nuts. And we know how this is going to end and it already ended:

With 7% mortgage rates after a 60% price spike in two years, sales have plunged, and those sales that are taking place are taking place at lower prices.

Over the past 20 years through early this year, home prices in expensive markets have tripled or quadrupled, according to the Case Shiller index. These markets include the metros of Miami, Tampa, Los Angeles, San Diego, Seattle, San Francisco, and others. The Case-Shiller index tracks 20 metros. There have been similar price spikes in other markets.

These price spikes are now getting hit by the 7% mortgage rates. And home buyers are reacting exactly the way they’re supposed to: They’re pulling back from agreeing to pay those ridiculous prices.

And we see that in the numbers everywhere, and they’re pulling back more every month. They’re pulling back because they cannot afford the mortgage payments at 7%; and even cash buyers, including institutional buyers that buy rental properties, they are pulling back; and they’re pulling back faster than regular home buyers, because they see how home prices are now skidding, and professional investors don’t want to buy at the top and ride the whole thing down.

The plunge in sales has just been stunning, and it’s getting worse. The most immediate view on what home sales might turn out to be, the most real-time view of current home sales, is the number of applications by home buyers for mortgages to purchase a home.

And those mortgage applications have collapsed by 42% in the latest week, compared to a year ago. They started plunging in February this year, as mortgage rates were rising, and they continued to plunge. And now they’re down 42% from a year ago.

But compared to early 2021, so that was roughly the peak of the housing frenzy, mortgage applications have collapsed by 52%. They are now well below the lows during the lockdowns in the spring of 2020. They now match the lows in 2015. And beyond that, they’re the lowest since 1995.

And as I said, investors are pulling out even faster.

This collapse in mortgage applications in October is an indication of where closed home sales will be, and when we’ll get this data in November and December, it’s going to be gruesome.

About ten days ago, the National Association of Realtors released the data for home sales that closed in September. And these closed sales in September plunged by 24% from a year ago and by 30% from October two years ago.

Closed sales in September were barely above the two lockdown months in the spring of 2020. But since then, volume, based on purchase mortgage applications, has gotten a lot worse.

Cash buyers and investors are pulling back even faster, and their share of total home sales has dropped further, now down to a share of 15%, from a share in the range of 20% earlier this year. They’re pulling back because they also see what’s going on in the housing market.

What’s going on in the housing market is that the housing market is now freezing up, with potential buyers not even willing to apply for a mortgage, and not even shopping for a home.

So sure, you will hear that the “right home, priced right, will sell,” and that’s nearly always true, but the key here is “priced right,” and “priced right” means priced where the buyers are, and not priced at some aspirational level in the seller’s imagination.

When the market is frozen like this, it’s the result of a standoff. The buyers are either not interested in buying or cannot afford to buy homes at those prices; those buyers are still there, but now they’re a lot lot lower.

And sellers don’t want to sell at prices that they could sell for, and so they don’t put the home on the market, or they pull it off the market after a couple of weeks of no traffic, and they’re muttering to themselves, “and this too shall pass.”

They’re hoping for a pivot by the Fed on interest rates, and they’re hoping for the Fed to restart the money-printing press, and they refuse to see that inflation is raging at over 8%, and that the Fed must get this raging inflation under control, and that the home price spike is feeding into this inflation, and that the price spike must be unwound to deal with this inflation.

So that pivot isn’t happening. The Fed now too sees that this inflation has moved into services, while fading in some goods, and that inflation raging in services is devilishly hard to stamp out, and services is where nearly two-thirds of consumer spending ends up, it’s the biggie, and when inflation in services takes off, it’s a huge mess, and that’s what we’ve got now.

This will take a long time to get under control, it may take years, nobody knows, and interest rates will go higher from here and stay high for longer than people expect because, after many years of global money printing, these trillions of dollars in excess liquidity are still chasing after everything.

For many years, QE and interest-rate repression didn’t trigger inflation. But then the dam broke 20 months ago, and inflation flooded the globe, and it’s even taking off in Japan, and it’s turned into a horror show in Europe, and underlying inflation is raging in the United States and Canada, and just isn’t backing off despite the rate hikes.

So potential home sellers now have a problem. Buyers have vanished at these sky-high prices, and sales that do take place are taking place at lower prices. Sellers a few months ago got higher prices than sellers today. And those who sell now are getting higher prices than those who’ll sell in a few months. Who panics first, panics best.

The last housing bust took five years to play out. Housing busts are not like crypto trading. There isn’t this sort of instant gratification that you get with cryptos when they plunge 20% while you’re asleep, or 60% or 90% in a few months. The last housing bust continued for years after the Fed started its interest rate repression and QE in late 2008 to bail out the banks. It didn’t bottom out until 2011.

Back then there was almost no inflation. Now there is raging inflation, and the Fed is trying to remove the fuel for this inflation before it becomes a much bigger problem, and the Fed won’t cut rates and restart QE with this kind of raging inflation. This time, there is no Fed put and no Fed bailout.

And this time, the housing bust won’t take down the banks, as it did last time, because the banks no longer own the mortgages. The whole industry has changed. Most of the mortgages are securitized into mortgage-backed securities, by entities such as Fannie Mae and Freddie Mac, which are under government conservatorship, or by Ginnie Mae and the Veterans Administration, which are government agencies, and the government guarantees the mortgages. And these mortgage-backed securities are sold to investors such as pension funds, insurance companies, bond mutual funds, etc. around the globe.

If mortgage credit blows up, if there’s another huge wave of foreclosures, it won’t hit the banks; it’ll hit taxpayers mostly, and investors to a lesser extent.

But we’re not seeing any signs of credit blowing up yet. Mortgage defaults and foreclosures are just now creeping up from the record lows during the pandemic and remain lower than any time before the pandemic. So we’re far from that happening, and if and when it happens, it’ll hit taxpayers and investors, and not banks.

So the Fed, which is in charge of keeping the banking system from toppling, won’t have to bail out the housing market because it won’t take down the banks.

And if it wants to because inflation is still raging, the Fed can just let the housing bust rip.

But we’re still far from that. Where we’re now is the moment when this splendid housing bubble popped. Prices are coming down, and they’re coming down hard in many places, and they’re coming down in most markets across the country.

According to the National Association of Realtors, the median price of all types of homes whose sales closed in September dropped for the third month in a row, and is now down 7% from the peak in June. The 7% decline was the largest drop for this three-month period since what I call “Housing Bust 1.”

There were housing busts before, but Housing Bust 1 was the first national housing bust in this millennium. Now we’re tinkering with Housing Bust 2.

According to the Case-Shiller Home Price Index, which lags reality on the ground by 4-6 months the way it’s structured, well, it’s now showing record-fast price declines in some metros, such as the Seattle metro, and the steepest declines since Housing Bust 1 in other metros. In some metros, prices plunged faster than they’d spiked. All metros in the index are showing price drops, and this was based on deals a few months ago, when mortgage rates were at or below 6%. Now they’re over 7%, and the housing market has frozen up.

I build charts for each of these metros. You can see them on my site Wolf Street.com. You can just Google the phrase, “The most Splendid Housing Bubbles in America.” One chart for each metro, going back 20 years. Those charts are just stunning, including the plunges in recent months. If you haven’t seen them yet, check them out.

So there are still sales taking place, but at prices where the buyers are, and buyers are a lot lower.

The real estate industry is now lamenting that homeowners aren’t putting the home they live in on the market, because they financed it at 3%, and they cannot move because they cannot afford to buy a home at 7% mortgage rates.

But in terms of inventory, this is a fake argument. Because if I buy a new home and sell my old home, I take one home off the market and add one home to the market, it’s a zero-sum game, and ultimately nothing changes. Realtors love it because they get paid their commission on the churn, and that’s why they lament the lack of churn. But in terms of the market, it changes nothing.

According to the Census Bureau, about 10% of all housing units are vacant. In San Francisco, the vacant home issue is such a problem that there is now a vacant home tax on the ballot.

When I buy a home and move into it, but don’t sell the home that I lived in because I want to ride the housing bubble all the way up, that’s when I took one home off the market, without adding one to the market. But eventually, when I want to sell it because now home prices are dropping, and the carrying costs are high, and this isn’t fun anymore, and maybe my stocks are down 25%, and bankers are breathing down my neck, well then when I put the vacant home on the market, that’s when I add a home without taking one off. And when lots of people do that, inventory jumps. That always happens during a housing bust.

But we’re still in the state of a standoff, when the housing bubble just popped, the state where potential sellers are still trying to outwait this, hoping for a Fed pivot that’s not going to come.

The actual sellers, those that put their home on the market and sold at whatever price they could get, well by panicking first, they panicked best. And the longer potential sellers are trying to hold out, the lower the price will be. And then they’ll end up chasing those prices on the way down. That’s what happened last time.

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