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Wednesday, July 28, 2021

Aaron Layman: The Federal Reserve has made another fine mess in the housing market

Aaron Layman

Aaron Layman.

Spring is in the air, but temper your enthusiasm. As February’s home sales numbers confirmed, the North Texas real estate market correction that began last year is still in play. The local housing market is still trying to sort through the distortions caused by the Federal Reserve’s interventions in the markets.

Dallas-Fort Worth home sales are still struggling to regain their footing, and home prices continue to roll over at the margins from the top down. What we are experiencing was years in the making. As I have detailed in numerous articles, the North Texas real estate market has the Fed’s fingerprints all over it.

If you happened to catch Jerome Powell, chief of the Federal Reserve, in a recent 60 Minutes interview, it was notable for many reasons. Since the December market nosedive, Fed officials have completely caved on policy normalization. Interest rate hikes have been halted, with the Fed funds rate at a measly 2.5 percent. The Fed has also announced that the balance sheet normalization formerly on autopilot will likely end this year. Turns out draining $50 billion per month was causing the market some serious grief.

Global central banks seem to have thrown in the towel on anything approaching “normal.” Despite the Fed’s recent balance sheet reductions, China, Europe and Japan continue to grow their central bank balance sheets to stimulate weak economic growth. The European Central Bank just expanded its set of loans (TLTRO) to prop up zombie European banks.

What does this have to do with the housing market in Denton? More than you might imagine!

The United States is on the cusp of the longest economic expansion in history. In just a few months, we will probably cross that line. Unfortunately, the latest “recovery” has come at a tremendous cost. It now takes much more debt to fuel economic growth (GDP).

U.S. public debt is now more than $22 trillion. Total consumer debt is at a record $13.5 trillion. While housing debt has declined since the last bubble peak, we have over $1.5 trillion in student loan debt and over $1.2 trillion in auto loan debt. A record 7 million Americans are delinquent on their car loans.

While the averages paint a picture that the U.S. economy is still performing relatively well, the averages are misleading because the Fed’s “wealth effect” has not translated into shared prosperity. In fact, it’s been quite the opposite. The U.S. housing market is Exhibit A for the wealth inequality facilitated by the Federal Reserve’s trickle-down monetary policy.

“Trickle-down theory — the less-than-elegant metaphor that if one feeds the horse enough oats some will pass through to the road for the sparrows,” John Kenneth Galbraith said.

The local housing market is now suffering from the Fed’s trickle-down policies and the bifurcation created by pouring trillions of new liquidity into a financial system that remains unreformed and poorly regulated. The divide between the haves and have-nots just continues to grow wider. This is manifesting in the housing market on multiple levels.

Existing owners of assets have done pretty well during the latest recovery, but prospective homebuyers are in a pickle. You might think it would be relatively easy to find a decent home in Denton for $200,000 or less, but that task has been complicated by the Fed’s artificial inflation of asset prices across the spectrum.

In the summer of 2008, the average price of a home in Denton was roughly $158,000. In the summer of 2018, the average price of Denton homes was more than $275,000. That’s a 75 percent increase. During the same time frame, median and average household incomes in Denton haven’t come close to matching that kind of growth. Sooner or later, something had to give, and it has.

Now that the local housing market is cooling, we are seeing a tug-of-war between buyers and sellers. Many sellers are still holding out for prices that seemed reasonable a year or two ago when the market was red-hot and multiple offers or bidding wars were the norm. Homebuyers, particularly debt-strapped millennials, are increasingly looking for value where they can find it. Many are just choosing to rent.

It was plainly obvious to anyone paying attention that the Fed couldn’t hike rates and remove the amount of liquidity from the markets it was discussing without some serious consequences. The December 2018 wake-up call was just one of those consequences.

Mortgage interest rates didn’t even hit 5 percent before home sales started rolling over, because U.S. consumers are far more interest rate sensitive than many Fed officials imagined. Fed leaders have been so preoccupied with sustaining the “recovery” that they failed to appreciate the market distortions they were causing.

The spring selling season should be very interesting. So far in 2019, the precipitous drop in mortgage interest rates has provided some support to the housing market. That doesn’t mean the real estate market correction has ended. Despite the hope and rhetoric of many housing market pundits and real estate agents, the economic cycle has not been replaced.

Powell’s 60 Minutes interview was full of half-truths, obfuscation and public relations spin. One thing that was painfully clear from the interview is that the Federal Reserve learned nothing from the recession of a decade ago. Powell said the Fed would consider more quantitative easing if the economic circumstances warranted it.

This is despite the overwhelming evidence that quantitative easing — massive injections of Fed liquidity — has not produced a shared wealth effect. It has produced wealth inequality, inflated home prices, rampant speculation and banks that are now larger than ever.

These imbalances will continue to pose headwinds for the housing market until the larger economic cycle is allowed to function as intended. The longer the Fed attempts to thwart market forces, the larger the imbalances and distortions become. For better or worse, the Denton area’s real estate market is still captive to Federal Reserve policy.

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