A worker at Canal Crossing, a luxury apartment community in Hamden, Conn.
Spencer Platt/Getty Images
Driving with one foot on the brake and the other pressing the gas pedal to the floor. That describes the housing market, with the Federal Reserve pumping fuel into the system while supply and affordability constraints slow things down. At the very least, this is costly; at worst, it risks serious overheating and a breakdown.
Soaring house prices these days get play on general television news and the front pages of newspapers, not just the business section. The story has progressed from one about the exodus from cities under lockdown from the Covid-19 pandemic, setting off a scramble that has pushed up prices of existing homes by 23% in a year. Now, shortages of building materials, land, and labor have worsened the squeeze, potentially braking home construction.
Throughout the saga, the Fed has provided tanker cars of liquidity, by slashing its short-term interest rate target to near zero and by buying $120 billion of securities per month since the spring of 2020 to counter the pandemic’s economic impact.
The rapid, aggressive response by the monetary and fiscal authorities, which included the passage of the $2.2 trillion Cares Act, resulted in the shortest recession on record, starting in February 2020 and ending just two months later, the National Bureau of Economic Research, the arbiter of such matters, announced this past week.
While the recession officially ended 15 months ago, the central bank continues its emergency-level policy. As the Federal Open Market Committee meets this coming week to plot near-term policy, the bond-buying surely will be a key topic, as Fed Chairman Jerome Powell indicated in his congressional testimony on July 15.
A question that many critics want answered is whether the Fed will continue purchasing $40 billion of agency mortgage-backed securities per month while the housing market is superheated. Powell testified that the impact of MBS buying isn’t significantly different from that of the Fed’s monthly purchases of $80 billion of Treasury securities, because the bond market sees the two sectors as similar.
That $40 billion of net monthly mortgage securities purchases actually is an understatement, says Barry Habib, the founder and head of MBS Highway, an advisory firm. After taking into account reinvestment of interest and principal payments that homeowners make on their mortgages, plus cash flows from refinancings, the Fed actually is buying about $100 billion of MBS a month, he contends. He notes that the FOMC’s policy directive now specifies purchases of “at least” those amounts of agency MBS and Treasuries.
Habib estimates that the MBS buying has lowered mortgage interest rates by 25-35 basis points. (A basis point is 1/100th of percentage point.) That amounts to a subsidy for creditworthy borrowers, who would qualify for conventional loans that qualify for purchase by Fannie Mae and Freddie Mac, and for larger, jumbo loans held by private lenders. But he notes that halting Fed purchases would hurt borrowers who get FHA- and VA-guaranteed loans, which are purchased by Ginnie Mae. (Those government-sponsored enterprises pool the loans into mortgage-backed securities that can be purchased by investors, including the Fed.)
Anticipating the eventual end to the central bank’s buying, the market already has increased the yield spread on agency MBS over comparable Treasuries by about 20-30 basis points, says Walt Schmidt, the head of mortgage strategies at FHN Financial, an institutional fixed-income firm. But the widening hasn’t been nearly as severe as it was during the 2013 “taper tantrum,” which he notes started in the MBS sector, even before then-Fed chief Ben Bernanke said the Fed would begin to wind down its securities purchases.
What’s also different now is how red-hot the housing market is. Builders can’t keep up with demand, as the fiscal third-quarter earnings report from D.R. Horton (ticker: DHI), the nation’s biggest builder by volume, suggests. Even though net income per share rose 78%, year over year, topping analysts’ forecasts by 8%, its stock slumped 2% Thursday.
Future orders were down, not because of a shortfall in demand, but because the company is holding back sales. “Based on the stage of completion of our current homes and inventory, production schedules and capacity, we expect to continue restricting the pace of our sales orders, D.R. Horton’s chief financial officer, Bill Wheat, said on the analyst conference call, Reuters reported.
The inability to keep up with demand is an enviable problem for any company. And Habib says the housing market’s fundamentals are strong from the “explosion” in births around 33 years ago. Consumers born then are entering their peak years for starting families and buying homes. He adds that, in part because of less-lax lending standards, the current situation is nothing like the bubble of the 2000s, when it “was one person buying four houses” as a speculation.
D.R. Horton’s shares are off 14% since their peak in May, about average for the home-builder group, which is suffering as tight supplies and high prices counter strong demand. While builders struggle to get enough materials, appliances, and labor, the Fed can keep buying agency MBS with dollars created by a mere mouse click.
More money chasing too few goods is the textbook definition of inflation, which has been deemed “transitory” by the Fed. An increasing number of central bank officials have begun to argue that the time has come, or at least is approaching, to do more than just talk about tapering the $1.44 trillion of annual bond buying.
The builders’ stocks’ recent performance suggests that the central bank isn’t helping by keeping the gas pedal floored amid supply constraints.
Write to Randall W. Forsyth at [email protected]
