Irrational Exuberance

| April 15, 2022

We are rapidly heading for another housing bubble, even if this time it will be a little different. Yes, Congress will be largely responsible, even if for different reasons. Investor psychology will again play a role since fear of missing out (FOMO) is hard-wired into our natures. I know from long experience that most people are deaf to reason when in the throes of FOMO. This is what makes bubbles inevitable.

Real-estate bubbles have been the cause of recessions and depressions since Andrew Jackson went to war against Nicholas Biddle, president of the Second Bank of the United States. I shall not go into the history of our decentralized banking system here. The important point is that real estate is unique in the fact that most homes have traditionally been financed by banks. Moreover, we grant a bankruptcy exemption to real estate, allowing borrowers to walk away from homes that are worth less than the amount owed to the bank. The question today is whether or not the financial system is healthy enough to withstand the fallout when the bubble inevitably bursts.

There are good reasons for elevated housing prices today. Pandemic shutdowns created a shortage of labor that has slowed the construction of new homes. Likewise, global supply chain problems make it difficult to catch up to demand. Massive fiscal stimulus increased the wealth available to buy houses at the same time that the Federal Reserve (Fed) lowered interest rates to historic lows. The Fed also bought mortgages from lenders, thus making more money available to lend.

Clouds are visible on the horizon though. According to The Economist, “nearly 1.6m homes are under construction nationwide, the most since the early 1970s.” * When labor and supply chain problems ease, so too will the housing shortage. The Fed will soon stop buying mortgages, reducing the amount available to lend. They may even begin selling mortgages, pulling excess capital out of the economy. Adding to the affordability problem is the fact that mortgage rates have already shot up.

Banks and households today are in much better shape than they were during the last bubble. For those who need to buy a home and intend to stay in it through market cycles, go ahead and buy if you can afford to make the payments. For those who are planning to sell, now is probably the time. In the meantime, like Beethoven’s Fifth Symphony, FOMO will keep building until it reaches its crescendo.

For those who are interested in a more detailed explanation of the coming bubble, the Federal Reserve Bank of Dallas has a wonderful and relatively accessible analysis at Real-Time Market Monitoring Finds Signs of Brewing U.S. Housing Bubble -

* "The American Property Market is Once Again Looking Bubbly." The Economist, Online/Finance & Economics, Accessed on 04.12.2022.