The Fed plans to “reset” the housing market – increasing the likelihood of falling house prices

It’s not just about how expensive housing got — it’s about how quickly it got there. It took just 24 months for US home prices to soar by a staggering 37%. For comparison, the largest two-year spike that led to the 2008 housing crash was 29%.

Heading into this spring, the Federal Reserve decided it had seen enough. The central bank quickly hiked interest rates, taking the average rate on 30-year fixed-rate mortgages to 6% — up from 3.2% at the start of the year. These higher interest rates, which many homebuyers priced out, ultimately ended the pandemic housing boom. We are now in a sharp deceleration, the Mortgage Bankers Association reported on Wednesday Mortgage applications are down 16% year-on-year.

When this shift took place, we heard very little from the Fed. Well, that was until Chairman Jerome Powell spoke to reporters on Wednesday.

Here’s what Powell had to say: “We’ve seen [home] Prices have risen sharply in recent years. So that’s changing now. And prices have gone up. We are aware that mortgage rates have risen sharply. And you see a changing housing market. We’re watching it to see what’s going to happen. How much will it really affect housing investment? Not really sure. How much will it affect property prices? Not really sure. Of course we’re watching this very closely… It’s a very tight market. So prices could continue to rise for a while, even in a world where interest rates are rising. So it’s a complicated situation and we’re monitoring it very closely. I would say if you are a home buyer, someone or young person looking to buy a home, you need a bit reset to default. We need to get back to a place where supply and demand are coming together again, inflation is low again, and mortgage rates are low again.”

Three things stand out.

1. Powell says homebuyers “need a little something reset to default

In the housing industry, the total number of active offers is referred to as “inventory”. Annual inventories have been declining since 2014. This was caused in part by shifting household preferences (i.e. staying longer), lower housing construction after the 2008 housing crisis, and the start of millennial home buying for the first time. But as the pandemic housing boom took off, inventories began to plummet. By spring 2021, inventories hit a 40-year low. That has left homebuyers with little choice but to increase house prices.

It’s clear that Powell is hoping the housing slowdown caused by rising mortgage rates will help push inventories higher. Powell suggests it will help buyers, because the thought is that when buyers resume their home hunting, they will find a friendlier market. Higher inventories would give buyers more time to make up their minds and reduce the likelihood of having to engage in a bidding war.

Even before the Fed stepped up its inflation fight, Logan Mohtashami, senior analyst at HousingWire, openly advocated higher mortgage rates to bolster inventories. According to the National Association of Realtors, the US housing stock rose to 1.03 million by May. But to return to a “normal” housing market, Mohtashami says the stock would have to increase to between 1.52 and 1.93 million housing units. However, nationwide inventories (see chart below) are rising rapidly, and over half of the regional housing markets still have inventories 50% below pre-pandemic levels.

Check out this interactive chart on

“We need a balance… The housing market is still very unhealthy because total inventories in America are still below 1.52 million,” says Mohtashami.

2. Falling house prices? Powell seems to have suggested it is possible

Fed Chairman Powell hypothesized a fall in house prices on Wednesday: “How much will it affect house prices? Not really sure. Obviously we’re watching this pretty closely. You would think over time… There is a tremendous amount of supply of unfinished homes in the housing market and when they come online…”

He then turned and said: “While the supply of finished homes is for sale, the inventory of finished homes is incredibly low, historically low. It’s still a very tight market and prices could continue to rise for a while longer, even in a world where interest rates are rising. So it’s a complicated situation and we’re monitoring it very closely.”

For a moment, it sounded like Powell was saying house prices were going to fall. Regardless, Powell didn’t rule out falling home prices. That counts. Historically, outside of the Great Depression and after the housing crash of the 2000s, annual declines in house prices almost never occur. But today’s circumstances could bring us into a rare time when house prices actually fall. It’s telling that Powell hasn’t closed the door on the possibility of a fall in home prices, saying, “We’re watching it very closely.”

Last month, Mark Zandi, chief economist at Moody’s Analytics, said wealth that soaring mortgage rates have pushed us into a full-blown “housing fix.” In the near term, Zandi expects year-over-year home price growth to slow to 0% from 20.6%. He expects prices to fall by 5% to 10% in clearly “overvalued” housing markets. If there is a recession, Moody’s Analytics expects US house prices to fall by 5% and the significantly “overvalued” housing markets to fall by 15% to 20%. (Moody’s Analytics determined the “overvaluation” by comparing regional house prices to local underlying economic fundamentals, such as household income, which have historically been supported).

Check out this interactive chart on

Why are house prices vulnerable to a decline now? It starts with the fact that home prices have become detached from underlying economic fundamentals. Basic economic theory teaches that house price growth and income growth are intertwined and neither can long outpace the other. This affordability crisis has only been made worse by rising mortgage rates. In fact, the typical new mortgage payment is up 52% ​​over the past six months, according to Zonda, a real estate research firm.

Property prices can fall, however, but inventories will likely need to rise much more for that to happen. Once U.S. inventories climb above 2 million units, home prices nationwide could fall year over year, Mohtashami says.

If the Fed’s “over-tightening” causes a recession, inventories could reach levels that would allow house prices to fall, according to Ralph McLaughlin, chief economist at Kukun, a real estate data and analytics firm.

“It’s looking increasingly likely that we’re approaching a sharp turning point in the market,” says McLaughlin wealth.

3. Powell specifically said he would like to see mortgage rates go down

The central bank hiked interest rates to both stem the pandemic housing boom and curb runaway inflation. Once the Fed gets inflation under control again, the hike in mortgage rates could ease.

Check out this interactive chart on

That means homebuyers anxious for mortgage rate relief might wait a while. Last week the consumer price index was 8.6%. The Fed will not give up the fight against inflation until CPI returns to 2%. On Thursday, the Fed made it clear that this fight could last well into 2024.

Hungry for more apartment data? Follow me on Twitter at @NewsLambert.

This story was originally published on

Leave a Comment