Dallas Fed sees signs of a housing bubble

A housing bubble could be brewing, according to the Federal Reserve Bank of Dallas, as home prices “are again becoming unhinged from fundamentals.”

The housing market has been showing signs of exuberance for more than five straight quarters through the third quarter of 2021, the Dallas Fed found using a measure it created to detect fever-pitch conditions. Exuberance occurs when home price growth exceeds what certain economic factors — in this case, rent, disposable income, and long-term interest rates — would justify.

While this “abnormal” behavior hasn’t been seen since the boom of the early 2000s, it doesn’t necessarily mean a housing bust like the one that preceded the Great Recession is in the offing.

“While the current evidence is concerning, suggesting that the housing market is becoming frothy, as we note in our report, rising mortgage rates … might help cool down housing demand,” Enrique Martínez-García, senior research economist at the Federal Reserve Bank of Dallas, told Yahoo Money, “at the expense of aggravating housing affordability in the short run.”

‘Fear of missing out’ can drive prices up

While homebuyers are facing some of the worst affordability conditions, many aren’t giving up easily, creating a cycle of rapidly rising prices.

The national median listing price reached $405,000 for the first time in March, according to data from Realtor.com, up 13.5% versus last year and up 26.5% compared with March 2020.

Record low inventory levels and stiff competition have also added pressure on surging prices. Housing supply listed on the market fell 18.9% in March compared with a year ago, and was down 62% from two years ago.

“Real house prices can diverge from market fundamentals when there is widespread belief that today’s robust price increases will continue,” researchers wrote in the Dallas Fed report. “If many buyers share this belief, purchases arising from a ‘fear of missing out’ can drive up prices and heighten expectations of strong house-price gains.”

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Mortgage rates may flatten housing bubble

Mortgage rates, which have increased at a breakneck pace ahead of the spring housing market, could counteract the exuberance.

Last week, the average 30-year fixed rate mortgage jumped a quarter-point to 4.67%, according to Freddie Mac, the highest level since December 2018. In the last three weeks, rates have jumped by the largest amount since May 1987 and are up 1.56 percentage points since the start of the year.

“Because mortgage rate increases are happening shortly after the boom has started to turn into what looks like a bubble, we are less concerned that this will result in a severe correction with the dire consequences of the previous boom that preceded the 2007-09 global financial crisis,” Martínez-García said.

For now, Federal Reserve measures to tighten monetary policy to calm inflation, will likely push mortgage rates up as investors respond to the market changes.

“This outlook is predicated on the idea that the Fed’s tightening will produce a soft landing of the U.S. economy, but we must remain cautious about the risks to the outlook,” said Martínez-García. “And that is why we stay vigilant and continue to refine our data and methods to better track the evolution of housing in real-time”.

Gabriella is a personal finance reporter at Yahoo Money. Follow her on Twitter @__gabriellacruz.

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