American real estate just spent another quarter in bubble territory, according to its central bank. The US Federal Reserve Exuberance Index shows US real estate was still exuberant in Q3 2021. A quarter before, the market fit the criteria set out by researchers to be considered a bubble. It also happened to be the quarter branch presidents warned a housing bubble is a concern. After a second quarter of the alarm bells going off, there’s now confirmation they weren’t just being overly cautious.
The Exuberance Index are indicators used to measure explosive price growth in housing. The Fed calls it their “smoking gun” indicator of a housing bubble, and should act as an alarm. By identifying a bubble early, they can pop it as quickly as possible, minimizing damage. Needless to say, it was created after the last US housing bubble nearly took out the global economy.
The Index identifies exuberance by looking for explosive price growth. That’s a friendly way of saying rapid price growth in excess of fundamentals. One or two quarters of exuberance isn’t much to worry about — it could have been a good season of Flip or Flop. If the growth becomes persistent, then it becomes problematic. Five or more exuberant quarters is when the whole market is declared exuberant. Exuberant markets are better known as bubbles.
The researchers believe exuberant markets will see a correction. A longer run of persistent growth typically requires a larger correction.
The US Real Estate Bubble Is Now 1.5 Years Old
American real estate is now two full quarters into an exuberant market. The Q3 2021 update shows US home buyers were still exuberant, logging a sixth quarter. People have been saying some markets are suffering from frothy activity for years. However, this is a national index. It’s the first time since the Great Recession that the entire US real estate market is now in a bubble.
It’s also the first time the Fed had a quantitative model warning them of a bubble in real time. It also happens to be the first time they’re ignoring their real estate bubble model. Take it in for a moment. This is what it feels like when memories are made.
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 Federal Reserve Presidents Warned As The Alarm Was Triggered
Exuberance is still above the threshold, but it’s tapering rapidly in the last quarter. The third quarter of 2021 is also when annual home price growth peaked. In hindsight, it’s also when Fed branch presidents began to warn about a real estate bubble.
In the end of Q2 2021, Reserve Bank of St. Louis President, James Bullard warned about housing. “I’m leaning a little bit toward the idea that maybe we don’t need to be in mortgage-backed securities with a booming housing market and even a threatening housing bubble here, according to some people,” he said. “We don’t want to get back in the housing bubble game that cost us a lot of distress in the 2000s.”
The president of the Boston Fed also started to mention housing in Q2 2021. “You don’t want too much exuberance in the housing market,” said branch president Eric Rosengren to the Financial Times. “It’s very important for us to get back to our 2 percent inflation target but the goal is for that to be sustainable… and for that to be sustainable, we can’t have a boom and bust cycle in something like real estate.”
Both warned in the second quarter of 2021, which is when the model would later confirm a bubble. Now we have a second quarter confirming an exuberant market. Fourth quarter data won’t be available for a few months, but the Fed has already begun to try and cool the market.
In November, they began to wind down their quantitative ease (QE) program. This program was flooding the market with cheap credit, driving home prices higher. Mortgage rates have already begun to rise, and activity has reduced. Though these are all relatively minor moves. While they’re tapering stimulus, less stimulus isn’t the same as stopping stimulus.
US home prices are still on fire, with people bidding up almost anything they can find. Meanwhile, the Fed is still wondering if they should wake up or if the smoke alarm is just malfunctioning.