How The Fed Wrecked The Dream Of Homeownership

Today’s Wall Street Journal pulled no punches with respect to the soaring cost of homeownership:

Homeownership has become a pipe dream for more Americans, even those who could afford to buy just a few years ago……it is now less affordable than any time in recent history to buy a home, and the math isn’t changing any time soon…… That means buyers get a lot less home for their dollar. Before the Fed started raising rates, a person with a monthly housing budget of $2,000 could have bought a home valued at more than $400,000. Today, that same buyer would need to find a home valued at $295,000 or less.

And, yes, you can blame the Fed for this baleful state of affairs, but not owing to the normal complaint that mortgage rates are too high.  Nor could the problem be remedied by government-imposed mortgage interest rate caps.

Actually, true mortgage rates are still sub-normal. What is way too high are home prices, and that condition is absolutely attributable to decades of interest rate repression, which is now taking a second bite of the apple owing to a severe, cheap-mortgage “lock-in” effect that is keeping millions of homes off the market.

With respect to super-cheap mortgage rates during the past decade and more, the home price inflation mechanism is simple: Homes are the quintessential leveraged asset—with current outstanding mortgage debt equal to nearly $13 trillion.  Accordingly, the marginal bid for properties is heavily debt financed, meaning that the lower real interest rates, the higher the market-clearing price of properties.

But now that home prices have been driven sky-high by cheap mortgage debt, prospective home buyers are being monkey-hammered by an economic double whammy. To wit, instead of going down as interest rates rise per the normal laws of economics, home prices are still going up owing to artificially scarce availability of units for sale. So when you multiply a higher mortgage rate times even higher home prices you get monthly mortgage payments that are way out of reach for an increasing share of US households.

What we are dealing with here, of course, are the purportedly “unintended” but predictable effects of the Fed’s heavy-handed attempts to set interest rates below—and usually deeply below—market-based levels. That is to say, the Eccles Building may not have intended to cause soaring home prices or to now cause owners to keep properties off the market in order to preserve low long-term mortgage rates, but that’s exactly what their foolish interest rate pegging policies have caused to happen.

So let’s unpack this Fed-caused mess one component at a time. At the current 7.5% nominal level, 30-year mortgage rates may seem high compared to the recent past, but viewed in the context of the last three decades they clearly are not.