#Economy #Great #Huge #Problem
Key takeaways
- High prices and mortgage rates have crushed the housing market, even as other parts of the economy boom.
- A long-standing housing shortage contributed to the housing crisis, along with anti-inflation interest rate hikes by the Federal Reserve, which sent mortgage rates soaring.
- It is possible that mortgage rates will decline next year, improving the outlook, but not necessarily solving the underlying problems.
Amid a recent wave of data showing the economy is running smoothly, one sector has consistently remained out of whack and it’s a big one: housing.
A report released by the Bureau of Economic Analysis on Thursday showed that rising housing costs helped push core inflation to a level above the Federal Reserve’s 2% annual target. The decline in home construction in the third quarter was a drag on the economy’s overall growth rate, according to a report on gross domestic product released by the bureau on Wednesday. Earlier in the month, data showed weak home construction and existing home sales fell to their lowest levels in more than a decade in September.
The beleaguered housing market is a stark contrast to other important pillars of the economy, which are running relatively smoothly: the labor market is holding on to an extended winning streak, consumers are spending freely, and inflation is falling.
At the heart of the problem is the fact that high prices and high mortgage rates have put the cost of buying a home out of reach for people with typical incomes who were previously able to afford the payments. The mortgage payment on a typical newly purchased home will account for 42% of median household income in August, up from 29% in January 2020, according to the Housing Affordability Monitor created by the Federal Reserve Bank of Atlanta.
Housing problems wreak havoc on the overall economy, hurt family budgets and prevent people from moving to take advantage of job opportunities, among other ripple effects.
High mortgage rates hurt budgets
The housing market has been collateral damage in the Fed’s war on inflation.
“When the Fed raises interest rates, it hits the housing industry hard because it is the sector that is most sensitive to interest rates,” Bill Adams, chief economist at Comerica Bank, said in an interview with Investopedia.
Mortgage rates have reached record levels during the pandemic, as the Federal Reserve kept its influential benchmark interest rate near zero to boost the economy. But when the Fed quickly raised interest rates in 2022 to combat inflation, mortgage rates soared. By October 2023, the average rate offered for a 30-year mortgage had reached a two-decade high of 7.79%, up from a record low of 2.65% in January 2021, according to Freddie Mac.
This hit has effectively paralyzed the housing market, as homeowners who received extremely low interest rates during the pandemic are reluctant to sell their homes and replace them with new mortgages at higher interest rates.
As a result of this “foreclosure” effect, there are far fewer homes on the market than before the pandemic, according to the National Association of Realtors. Home builders have been unable to keep up with the demand for new homes, in part because local zoning regulations restrict the construction of new homes where the demand is greatest. Furthermore, demand for larger homes has surged during the pandemic as workers have adapted to the new lifestyle of remote work.
“There’s been this big change in the amount of living space Americans want since the pandemic because a lot of Americans are working from home now or working from home some days,” Adams said. “Demand for living space in the United States is consistently higher than it was before the pandemic. It’s the other side of all those empty offices in the middle of big cities.
All of these forces have combined to repeatedly keep prices reaching record levels even though many buyers have been priced out of the market.
What’s next?
It is possible that one part of this equation – mortgage rates – will improve in the near future.
The Federal Reserve cut the federal funds rate from its highest level in two decades in September and plans further rate cuts in the coming months as inflation falls to its 2% annual target. While mortgage rates don’t always move in tandem with the federal funds rate, they are affected by it. Forecasters at Fannie Mae expect mortgage interest rates to fall to the mid-5% range by the end of next year, compared to 6.72% as of last week.
“2024 has been a really tough year for the housing market,” Adams said. “2025 should be a better year because the Fed is cutting interest rates.”
However, this outlook could change depending on which party wins Tuesday’s general election. Both presidential candidates have touted plans to ease the housing shortage, with Vice President Kamala Harris promising to build 3 million affordable homes and former President Donald Trump vowing to free up housing by deporting immigrants.
#Economy #Great #Huge #Problem
