Pandemic Real Estate Boom Due To Cheap Debt, Not Lack of Supply: US Federal Reserve

It’s the credit, stupid. That’s basically the conclusion from a US Federal Reserve Board staff paper. The paper, Volatility in Home Sales and Prices: Supply or Demand?, examined price levers. It paid special attention to the recent home price surge during the pandemic. The ultimate conclusion is stimulated demand was responsible for the surge, not a lack of supply. They join increasing amounts of central bank research at odds with political narratives around costs.

Demand Was Responsible For Most Price Gains Over The Past Two Decades

The researchers looked at short-run fluctuations in home sales and prices. Modeling various environments, they looked at both the supply and demand factors. They paid special attention to the pandemic boom, which sent home prices to record levels across advanced economies. Apparently everywhere having a shortage shortly after a monetary policy change produced skepticism. 

Shockingly, everywhere didn’t just see a shortage. They conclude, “… fluctuations in demand explain essentially all of the variation in home sales, and 80% of the variation in prices, between 2002-2021.” 

Supply Was A “Minor” Factor In Price Growth Over The Past Two Years

When the pandemic began, everything ground to a halt after public health measures. The cheap credit was too tempting, with buyer activity recovering shortly after. By mid-2021, the Fed concluded supply issues had been resolved. However, buying activity received the same stimulus as when there was no activity. 

Years of demand was pulled forward, producing record home buying activity. “We conclude that, outside of a brief shock at the beginning of the pandemic, reduction of supply was a minor factor relative to increased demand in explaining the tightening of housing markets,” write the researchers.  

Solving The Problem With Supply Makes No Sense

Many policymakers, with a rudimentary knowledge of economics, concluded it’s a supply issue. The Reserve found supply would have to rise 300% to balance stimulated demand. On paper, any supply and demand problem can be solved by balancing the other side of the equation. In reality, it makes no sense. It’s like that clueless boss you worked for as a teen, who thought saying “work harder” increased productivity.

The researchers don’t dive into this much other than suggesting increasing supply output that much, doesn’t make sense. But keep in mind, as impractical as increasing supply output by 300% is, it also assumes all else is equal. Cheap credit already sent materials and labor prices soaring. The US delivered a home for every 1.3 people the population grew by in 2021. It’s about 92% more than expected to handle the growth.

To scale it to 300% higher, more than 2 homes per person would need to be delivered. Input costs would surge and make the 300% goal perpetually higher. That’s why stimulated environments are short-term solutions, not how society should be organized. Having a fifth of the economy’s output based on sheltering 0.58% of the population every year, isn’t a great idea. Sustainable growth is boring, but a healthier solution.

“One implication of this result is that policies targeted at increasing supply, for example construction subsidies or zoning reforms, would have done little to cool the pandemic house price boom in the short-run,” conclude the researchers. 

The US Federal Reserve isn’t the only one catching on to the role cheap credit plays in driving home prices higher. The Bank of Canada (BoC) recently explained low rates drove home prices higher for the past 30 years. The assumption that people would save money on interest was wrong. They found the market absorbed the extra credit, scaling to consume higher prices.

Not sold on just two central banks explaining their own role in driving home prices higher? The Bank of International Settlements (BIS), the central bank for central banks, felt the same way. A few weeks ago, BIS published research showing low rates, held for too long, drove global home prices higher. Not just in one or two places, they explain monetary policy missteps were made across advanced countries.

They acknowledge other factors play a minor role, however cheap credit is the main reason. To correct it, they suggest central banks raise rates and throttle credit. By reducing the amount of liquidity, they can control home prices. 

But sure, these are just institutions whose only job is to control the price of goods with credit. What do they know?



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  • Michael 2 years ago

    “They found the market absorbed the extra credit, scaling to consume higher prices”. Just because someone can afford to pay $600,000 for a $400,000 home doesn’t make it a $600,000 home, it just means someone paid a $200,000 premium for the property. Unfortunately, this lesson was lost on many in the run up since 2015. How it ends is anyone’s guess given what has happened in the past 20+ years.

    • J 2 years ago

      People are paying 500K++8 premium on some of these homes. FOMO is strong in Canada. Same crap happened all over the world. Proper regulations required and transparency required. Follow that moolah (when, where, who, why, how) – arm a new agency and reward them 25% of the dirty cash. You’ll get geniuses working for the gov. at that point. 250k/M to catch the bad people, gogogo.

      • Michael Aniballi 2 years ago

        Hey J, I like your plan. After a few years and many houses and bidding wars it gets really challenging to determine the first house which triggered the stupidity (perhaps an offshore buyer with an extra $500,000 he needed to hide), and by the time you do find that one house, it has probably traded hands multiple times. Even if that first house was purchased with a “dirty money” down payment, enforcement would be nearly impossible, and even if it were possible, what does it matter, how could you unwind thousands of transactions which all escalated in price based off this one comp? To say this is complicated is an understatement. Sadly, the only way this problem gets solved is if real estate prices crater, people get wiped out and the whole system resets itself. It’s happened before and it can happen again.

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