The issue of housing cost continues to be a subject of great concern for both the Millennial and Gen-Z generations. Numerous articles and discussions have delved into the challenges posed by limited supply and affordability, with younger individuals being disproportionately affected. This was recently highlighted in a CNET article:
“The housing affordability crisis means it’s taking longer for people to become homeowners — and that’s especially impacting millennials and Gen Zers, economically disadvantaged families, and minority groups. There’s not one single driver of the crisis, but several colliding elements that put homeownership out of reach: rising home prices, high mortgage interest rates and limited housing supply. That’s on top of myriad financial challenges, including sluggish wage growth and increasing student loan and credit card debt among middle-income and low-income Americans.”
The chart below depicting the housing affordability index indeed substantiates these claims.
As highlighted by CNET, there are numerous visible factors contributing to the unaffordability of housing, from insufficient supply to elevated mortgage rates and soaring prices. During the past few years, as the Federal Reserve aggressively raised interest rates, the housing market supply expanded.
This phenomenon arose due to higher interest rates leading to increased mortgage rates and subsequently, higher monthly housing payments. It is important to note that historically, when the housing supply exceeded eight months, the economy was in a recession.
Simultaneously, higher interest rates and increased supply theoretically result in lower home prices, thereby enhancing “affordability.” This pattern was observed in previous periods, but post-pandemic, housing prices surged as “stimulus checks” led to a flurry of buyers.
Economics perennially revolves around the interplay of supply and demand, with price being a constant factor.
A Myriad of Unfortunate Choices Led to This Predicament
The following economic concept is a fundamental tenet of every “Econ 101” class. Notably, inflation ensues when supply is limited and demand surges.
Though this was apparent following the 2020 economic hiatus, the current housing affordability quandary stems from flawed decisions taken at the onset of the 21st century. Prior to 2000, prospective homebuyers were required to possess good credit and a 20% down payment. These requirements helped maintain a certain equilibrium between supply and demand. While housing prices rose in line with inflation, median household incomes were able to keep pace.
However, in the late 1990s, banks and realtors heavily lobbied Congress to modify laws, allowing more individuals to buy homes. The then Federal Reserve Chairman, Alan Greenspan, advocated for adjustable-rate mortgages, mortgage firms began employing split mortgages to circumvent the need for mortgage insurance, and credit standards were relaxed for borrowers. By 2007, mortgages were extended to subprime borrowers lacking credit history and verifiable income. Predictably, these actions led to a surge in demand that outstripped available supply, propelling home prices beyond the reach of median incomes.
This phase in the housing market resulted from zero-interest policies implemented by the Federal Reserve. These policies, coupled with copious liquidity injections into financial markets, attracted a flurry of speculators, ranging from individuals to institutions.
Noteworthy is the fact that institutional entities such as Blackstone (NYSE:), Blackrock (NYSE:), and various others acquired 44% of all single-family homes in 2023, primarily for rental purposes. As prices surged, platforms like AirBnB (NASDAQ:) further bolstered demand for rentals, subsequently reducing the available housing stock. These factors contributed to elevated prices for the limited available inventory.
Importantly, the issue does not stem from a dearth of housing construction. The Total Housing Activity Index is not far from its all-time highs in the aftermath of the 2020 pandemic-induced “housing rush.” The crux of the matter lies in the withdrawal of numerous homes from the accessible inventory by “non-home buyers.”
Furthermore, existing home sales are stagnating. Present homeowners are reluctant to sell their properties with a 4% mortgage rate to purchase a home with a 7% mortgage. As observed, existing home sales persistently lag.
All these developments have compounded the issue, with the common denominator being the prolonged low-interest rate environment perpetuated by the Federal Reserve. The surplus liquidity and subsequent recurring surgesThe increase in housing prices may be strongly linked to government interventions, paving the way for a widespread housing crisis.
What is the Resolution?
Senator Elizabeth Warren and three other legislators are urging Jerome Powell to decrease interest rates at the upcoming Fed meeting for the purpose of enhancing housing affordability.
“As the Fed considers its next moves in the coming year, we implore you to take into account the impact of your interest rate decisions on the housing market. The substantial rise in overall home purchase costs for the average consumer is a direct consequence of these exorbitant rates.” – Letter To Jerome Powell
As previously discussed, reducing interest rates does not provide a remedy for diminishing housing prices. Lower interest rates would draw more purchasers into a market already deficient in inventory, thereby inflating home prices.
We can already observe the influence of diminished mortgage rates on home prices since October. Prices surged as yields declined based on the expectation that the Federal Reserve would cut rates in 2024. If mortgage rates return to 4%, the level predominant for most of the last decade, home prices will undergo a significant rise.
There is only one solution to restore home prices to affordability for the majority of the populace, and that is to diminish the existing demand. Several measures could aid in resolving this predicament:
- Constrain corporate and institutional entities from purchasing individual residences.
- Elevate lending criteria to necessitate a minimum 15% down payment and a favorable credit score. (This would also bolster banks’ resilience against another housing crisis.)
- Amplify the debt-to-income ratios for homebuyers.
- Restore the mortgage market to exclusively feature fixed-rate mortgages. (Excluding adjustable-rate or split mortgages, etc.)
- Mandate that all mortgaging banks retain 25% of the mortgage on their balance sheets.
Undoubtedly, these are stringent standards to meet and initially, would exclude many from homeownership. However, homeownership should be accompanied by stringent standards, considering the high expenses involved.
For individuals, such standards would confirm the feasibility of homeownership and ensure that such ownership, along with ensuing charges, taxes, maintenance expenses, etc., still permits financial stability. For lenders, it would mitigate the risk of another financial crisis to almost zero, given that housing market stability would be inevitable.
Most crucially, such stringent standards would immediately result in a decline in housing demand. With a total lack of demand, housing prices would drop and reverse the extensive appreciation that transpired due to a decade of fiscal and monetary generosity. Undoubtedly, it would be a challenging market until those excesses diminish, but such is the implication of allowing banks and institutions to excessively influence the housing market.