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Bloomberg News
The Federal Reserve’s tough love approach for the housing market has fueled a long simmering debate about
After this week’s Federal Open Market Committee meeting, Chair Jerome Powell said the
“The housing situation is a complicated one, and you can see that’s a place where rates are really having a significant effect,” Powell said during his post FOMC meeting press conference. “Ultimately, the best thing we can do for the housing market is to bring inflation down so that we can bring rates down, so that the housing market can continue to normalize. There will still be a national housing shortage, as there was before the pandemic.”
When the Fed raises interest rates, its goal is to curb demand in the market by increasing borrowing and financing costs. For the housing sector, the thinking goes, as mortgages become more expensive, fewer people want to buy homes and prices stabilize.
But some economists say reality is not so simple. Mark Zandi, chief economist at Moody’s Analytics, said the elevated rates are not only curbing demand for new mortgages, they are also weighing on the supply side of the housing market in various ways, making it more costly to acquire land and develop both rental and for sale homes.
Zandi added that many existing homeowners feel “locked in” to their current, ultra-low mortgage rates, “thus limiting the supply of existing homes for sale, and reducing demand for homeownership and thus increasing rental demand and rents.” This is especially significant given that rents — and rental equivalents for owned homes — are how shelter costs are measured in inflation indexes.
“Given the unusual circumstances in the nation’s housing market, the higher rates are weighing on housing supply, pushing up rents and housing inflation as measured by the CPI and PCE deflator,” Zandi said.
Meanwhile, other economists and policy experts support the Fed’s approach. Diane Swonk, chief economist at the financial services firm KPMG, said cutting rates would induce greater demand in an already supply-constrained market, thereby increasing prices further without addressing the key factor holding back new supply: local zoning and land use laws.
“Washington can point at the Fed and say fix [the housing market], but the Fed doesn’t really have the tools to fix it,” Swonk said. “The tool they do have, if they were to wield it right now, the fear is that they would just stoke a more pernicious bout of inflation rather than defeat it.”
But others say the Fed has another tool to address housing affordability in a more meaningful way than by cutting interest rates alone: its balance sheet.
At the onset of the pandemic, the Fed purchased mortgage-backed securities en masse as part of a quantitative easing effort aimed at keeping financial markets functional. Its MBS holdings more than doubled during the next two years, peaking at $2.7 trillion before the Fed began allowing the assets to roll off their books. It still holds more than $2.3 trillion of mortgages today.
“The Fed bought way too many mortgages for way too long in the name of COVID relief and is now, somehow, perplexed that home prices continue to appreciate,” said Aaron Klein, a senior fellow in economic studies at the Brookings Institution. “Part of the problem was caused by the Fed’s balance sheet purchases. The solution may also lie on the balance sheet.”
The Fed’s mortgage holdings — which include securities backed by the government-sponsored entities Fannie Mae, Freddie Mac and Ginnie Mae — make up a significant portion of the overall market for outstanding agency MBS, which totals more than $9 trillion.
The Fed’s purchases provided liquidity to the mortgage market, driving down yields and driving up asset prices. To reverse this, Klein said, the Fed could sell its MBS assets into the market, though he noted that such a move would not be welcomed by existing homeowners.
“Having propped up home prices, the Fed is now loath to lower home prices,” he said. “It’s very politically unpopular to lower somebody’s home price.”
Mark Calabria, the former director of the Federal Housing Finance Agency, notes that the Fed’s preference for continued higher rates does not preclude it from driving down its MBS holdings more aggressively.
Calabria agrees that it would be premature to cut interest rates, noting that inflation also factors into mortgage costs.
“Ultimately, expected inflation enters mortgage rates,” he said. “The current rates are not simply a reflection of Fed tightening but also reflect inflation expectations.’
At the same time, Calabria said the housing market would benefit from the Fed shrinking its mortgage holdings more quickly.
“The Fed should never have purchased so much MBS in the first place,” he said. “The best move now would be to sell off more of its MBS.”
Some Fed officials have said the Fed should seek to exit the mortgage market entirely. Fed Gov. Christopher Waller has said he’d like the Fed’s
As part of its quantitative tightening campaign, which began in June 2022, the central bank is allowing up to $35 billion of mortgage securities to mature monthly without replacing them.
To this point, mortgages have rolled off the Fed’s balance sheet more slowly than Treasuries. Since the Fed began this round of quantitative tightening, its MBS holdings have declined roughly 13%, compared to 22% for Treasuries. This is in part because of the higher cap on Treasuries, but also because mortgages typically have longer durations. Higher interest rates have led to fewer refinancings, thus limiting the number of mortgages being paid off early, too.
The debate about whether higher rates do more to help or hurt the housing market has centered, in recent months, on the outsize role shelter costs have played on the overall inflation picture.
The Bureau of Labor Statistics’ Consumer Price Index, or CPI, report for May, which was released this week, showed shelter costs are up 5.4% over the previous 12 months, compared to an overall inflation reading of 3.3%, or 3.4% when factoring out food and energy costs.
During his post FOMC press conference, Powell said the stickiness of housing inflation readings is partially the result of how that category of price growth is measured. U.S. inflation indexes focus on rental costs — along with estimates of owner’s equivalent rent for owner-occupied properties — which rose sharply after the COVID crisis subsided. Because these changes are only recorded when new leases are signed, Powell said it has taken longer than expected for data to reflect recent slower price growth.
“What we’ve found is that there are big lags,” he said. “There’s sort of a bulge of high past increases in market rents that has to be worked off, and that may take several years.”
Mike Frantantoni, chief economist for the Mortgage Bankers Association, noted that the Fed’s preferred measure of inflation — the core personal consumption expenditures, or PCE, price index — applies a smaller weight to shelter costs. This is why this inflation reading, which came in at 2.8% in April, is even closer to the Fed’s 2% target than CPI.
While some say this reading is close enough to begin relaxing monetary policy — with the hope that a more normalized housing market could help carry it the rest of the way — Frantantoni said this is a gamble that carries more risk than reward for the housing sector.
Frantantoni said lower rates would lead to more construction activity and alleviate lock-in effects, but noted that those changes would take a long time to play out and, ultimately, provide benefits to the market. He would rather see the Fed wait until price growth has stabilized across the board before trimming its policy rate.
“Changing their monetary policy framework to ignore shelter prices now, at the onset of a rate cutting cycle, would not be a good tactical move,” he said.
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Kyle Campbell
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