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The US economy has surpassed expectations in recent years, despite challenges such as the pandemic, US-China tensions, the conflict in Ukraine, and political turmoil in Washington. It has experienced a resilient economic cooling, a strong job market, and robust gross domestic product (GDP) growth. In comparison to other countries, the US economy appears to be in excellent shape. However, there is a significant issue that stands out — housing.
This problem is evident in the latest consumer price index (CPI) data, which showed higher-than-anticipated inflation. Housing, along with food and fuel prices, was a major contributing factor. The shelter index of the CPI increased by 7.2% over the past year, accounting for over 70% of the total increase in all items, excluding food and fuel.
These inflation figures raise the possibility of future interest rate hikes by the Federal Reserve, contradicting expectations that rate increases were over.
But is raising interest rates the best solution to address the housing problem in the US? There is a strong argument that it is not. Housing has been a core component of inflation in America for some time. Unlike other markets, such as the UK, where prices have dropped significantly, the American housing market remains unaffected by multiple interest rate hikes.
In fact, one can argue that rate hikes have exacerbated issues in the housing market. How can this be explained? It begins with a fundamental problem — a shortage of housing supply relative to demand in the US. Since the 2008 financial crisis, housing production has failed to keep up with household formation, leaving the country millions of units short of meeting its population’s needs.
This shortage is partly due to nimbyism, which refers to the resistance towards housing projects at a local level. While many Americans acknowledge the need for more affordable and general housing in major cities like New York, Los Angeles, and San Francisco, few homeowners or renters would agree to have such projects near them.
Studies have shown that city politics related to zoning tend to favor opponents of housing plans rather than developers. This is a significant reason why housing supply remains limited.
The issue is exacerbated by an influx of migrants to sanctuary cities in the US, where guaranteed shelter is theoretically available but not practically achievable. Inflation in materials and labor since the pandemic has also affected new home construction, making it unaffordable or discouraging its development.
Housing remains one of America’s last remaining supply chain problems. While fuel prices have increased, they will eventually stabilize as US wells produce more and OPEC adjusts supply. However, the housing inflation issue, which has unwittingly been worsened by the Fed, is unlikely to disappear soon. The combination of home prices and mortgage rates is unfavorable for homeowner mobility.
The current 30-year fixed mortgage rate in the US is approximately 8%, up from under 3% in 2021. Meanwhile, the median house price has risen by 29% from $322,000 in 2020 to $416,000 today. Additionally, many homeowners locked in very low rates in previous years. Unless their rates reset, it is challenging to justify moving houses.
For example, my husband and I have a variable rate of 2.875% that will not reset until 2031. Despite my desire to downsize from our family home since our second child is leaving for college next year, the current housing market, high mortgage rates, and taxes associated with home sales in places like New York make it financially illogical for us to move — we would pay more for less.
This dynamic is what keeps prices high, even in the face of rising rates. It also contributes to continued inflation, especially if rates continue to climb.
Given this confluence of factors, some economists are urging the Fed to reconsider its traditional approach. Dan Alpert, managing partner of Westwood Capital and a professor at Cornell Law School, believes the Fed should think more creatively about addressing housing market inflation when considering rate increases.
If the current high prices, high rates, and inadequate supply persist, something will eventually have to give. While a major housing market correction may not occur in the US soon due to the number of people with low mortgage rates, managing America’s housing affordability crisis will become increasingly difficult without significant increases in housing construction in the coming years.
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