Quantitative ease (QE) is a simple concept, but not well understood by most people. Increasingly folks tell me, “QE inflates home prices,” and “prevents prices from dropping.” The first part is true, but the evidence on the second part is a little shaky. It can help to push home prices higher during a tight market, but it also extends inefficiencies. When market inefficiencies are extended too far, it can lead to market failure. If that happens, QE isn’t particularly effective at kickstarting home prices. It can sometimes make things worse.
Quantitative Ease (QE)
First, let’s clarify the basics of supply and demand. When demand grows faster than supply, the price of supply generally rises. If supply grows faster than demand, the price of the supply will generally fall. Most importantly, this doesn’t just apply to buyers and sellers of real estate. It applies to every aspect of a traded commodity, especially credit.
Most people get the home price part, but not a lot of people think about the credit creation part. It’s not as simple as, a lot of people want a product, so prices rise. Prices are bound by the limits of what people can and are willing to pay. Keep this in mind, because we’re going to circle back to it.
Quantitative ease (QE) is when central banks, like the BoC and the Fed, buy bonds or mortgage securities. These state players, with unlimited capital, create demand for these debt instruments. By creating demand, they drive the price up, and the yields on these instruments. Yield is another way of saying the return on capital lent, or the percent paid to you.
The goal is not just to lower yields, or interest paid on the instruments they buy though. Since markets compete for the same capital, the goal is to drop all interest paid lower. By making debt cheaper, they hope companies and households will borrow more. If they borrow more, they can spend more of their future revenue in the near term. This can boost the economy short-term until debt builds up and it’s no longer effective.
Still think this is just one interpretation of the events? Let’s check in with what the Bank of Canada says about QE:
“When the Bank buys government bonds of a given maturity, it bids up their price. This, in turn, lowers the rate of interest that the bond pays to its holders. When the interest rate on government bonds is lower, this transmits itself to other interest rates, such as those on mortgages and corporate loans.”— Paul Beaudry, Deputy Governor Dec 20, 2020
Despite many people protesting the impact of QE, that’s the goal. Driving mortgage rates and increasing mortgage borrowing is a stated goal. It’s not just a happy accident.
How QE Impacts Home Prices
Lowering the cost of debt does two things — pulls forward demand, and increases budgets. For mortgages, the cheaper rates allow buyers to handle more debt earlier. Ideally, they can use the lower mortgage payments to offset some down payment savings. Or even afford mortgage payments sooner than if they had to wait for a raise. By allowing buyers to purchase sooner, they create more demand in the short term.
Increasing the budgets of the current buyers works in tandem with this mechanic in a busy market. The demand pulled forward, which means more competition for the same units. Existing buyers, who can now spend a little more, can absorb price increases more easily. If a market is busy, the combination of these two can make home prices go parabolic.
Think of it like a tube of toothpaste. If there’s a cap on the tube, squeezing it won’t send toothpaste everywhere. If you take the cap off and give toothpaste room to flow, it will make a mess. Arguments of things like density are entirely secondary to credit expansion. You can’t get blood from a stone, or squeeze toothpaste out of a capped tube.
Folks like to argue factors like density, and the limited supply is behind higher prices. However, those factors are entirely secondary to pay. If density were the primary factor, Haiti and Mumbai would be more expensive than Toronto. Instead, Toronto is a city with a density similar to Philadelphia, trading at more than 3x the price. It has to do with how much people can, and are willing to pay.
Great, QE Can Inflate Home Prices Forever?
Short answer, no. The longer answer, extending market inefficiencies works until it doesn’t. Japanese real estate is the only market that has shown the long-term effects of QE on a real estate market. The country’s epic bubble pop in the 90s led them to a nearly zero rate policy by 1999. By 2001, they dabbled in QE — having no room to cut anymore. They’ve flooded their commercial banks and households with credit for 30 years now. It doesn’t work.
Japanese Residential Real Estate PricesAn inflation adjusted index of Japanese home prices. Source: BIS; Better Dwelling.
Japanese real estate prices peaked in the early 1990s, and still haven’t recovered. Real home prices peaked in Q1 2019, and are 38% below Q3 2020. Despite trying to use QE to bring the market up in 2001, it had virtually no effect.
Some blame this on Japan’s shrinking population, but timelines are important. Japan’s population stopped growing after its epic real estate bubble collapse. Not before.
Japan’s housing bubble may have actually resulted in a falling population. Low rate policy to preserve home prices meant extending credit faster than wages. Young adults found themselves with home prices that were still out of reach, while job stability disappeared. A totally not relatable story, I know.
From 1995 to 2007, the number of irregular employees in the country increased by 7.6 million people. Today about 40% of the population is employed regularly and would struggle to live on their own. This has led people to stop “coupling,” citing economic insecurity as the number one reason. TL;DR they tried to save home values at the price of a generation. It didn’t work, and the spectacular screw-up destroyed both.
QE can boost home prices if used in a booming market, and has been used to stop prices from cratering. However, extending structural inefficiencies with home prices can lead to the long-term failure of markets. When that happens, it doesn’t quite provide the juice people might think it will if housing impacts labor. A trend countries like Canada are being warned about in the current situation.
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