The American Real Estate Bubble Is Finally Mentioned By Federal Reserve Researchers

US real estate is in the first bubble since the Great Recession, and they might actually address it in time. In December, we revealed a little-known model from the Dallas branch of the US Federal Reserve showing US housing in a bubble. Central bank researchers maintain the model as an early warning system, allowing policymakers to pop them early. Researchers behind the model finally commented on it, confirming it’s a bubble. Since credit is already tightening, a correction is unlikely to be a 2008-style meltdown. 

US Real Estate Is Officially In A Bubble

US Federal Reserve researchers found home prices are rising much faster than fundamentals. The exuberance index shows US housing logged a sixth quarter of exuberance in Q3 2021. Once a fifth quarter of exuberance is logged, the whole market is considered to be exuberant. An exuberant market is better known as a bubble. 

US Real Estate Exuberance Index

The US Federal Reserve Exuberance Index for American real estate, and critical value threshold. A market that is above the threshold for 5 consecutive quarters is considered to be exuberant.

Source: US Federal Reserve; Better Dwelling.

“US housing market has been showing signs of exuberance for more than five consecutive quarters through third quarter 2021,” said researchers from the Dallas Fed, who designed the early warning system. “The exuberance statistic confirms that recent increases are far from ordinary.”

The US Real Estate Bubble Is Confirmed by Other Measures As Well

The Exuberance Index was designed as an early warning system to limit the impact of a bubble. After the US Housing Bubble in ‘08, the researchers set out to find a “smoking gun” to identify bubbles early. Early identification allows a central bank to pop the bubble before it turns into a bigger issue. By minimizing the economic inefficiency, they reduce the impact and produce a healthier economy.

“Our evidence points to abnormal US housing market behavior for the first time since the boom of the early 2000s,” the researchers warn. It’s not just the indicator, though, but other signs confirming a bubble. “Reasons for concern are clear in certain economic indicators—the price-to-rent ratio, in particular, and the price-to-income ratio—which show signs that 2021 house prices appear increasingly out of step with fundamentals.”

US Real Estate Is FOMO-Driven, Not Low Rate Driven

Low interest rates played a big role in sparking higher demand, but a fear of missing out (FOMO) caused a bubble. “While historically low interest rates are a factor, they do not fully explain housing market developments,” said the researchers.

Exuberance is an explosive growth in home prices that outpaces buying. “… real house prices can diverge from market fundamentals when there is widespread belief that today’s robust price increases will continue,” explain the analysts. “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.”

It’s just supply and demand, though, right? Many assume if homes are being sold, then there’s fundamental support. It turns out making money, or seeing others make money, can drive excess demand. “The resulting fundamental-driven higher house prices may have fueled a fear-of-missing-out wave of exuberance involving new investors and more aggressive speculation among existing investors.”

The US Real Estate Bubble Is Nothing Like The 2008 Bubble

Ever since the US real estate bubble in 2008, people think a housing crash is catastrophic. That’s rarely the case, and prior to 2008, no one thought that. Real estate crashes were supposed to be local, not spill across the globe. Now they know better, which is why they try to highlight the issue as quickly as possible. Researchers note this in more technical terms in their assessment.

“Based on present evidence, there is no expectation that fallout from a housing correction would be comparable to the 2007–09 Global Financial Crisis in terms of magnitude or macroeconomic gravity,” they write.

The Exuberance Index is considered a real-time indicator, but lags significantly. They’re only addressing Q3 2021 exuberance, which is likely worse by now. Higher mortgage rates only began to really climb this year, throttling credit to home buyers. By the time the Fed addresses anything, it will likely be the 9th quarter in a bubble.

That’s still relatively fast for addressing a bubble. Canada logged its 26th quarter in a bubble when only the 6th was declared in the US. Experts don’t see much fallout in Canada, and if that’s the case it’s hard to see housing spill over into other parts of the economy in the US. Homebuyers might want to make sure they can definitely pay that mortgage, though.