Affordability Squeeze Depresses Home Sales

Prospective homebuyers are confronting what the National Association of Realtors (NAR) describes as “the most difficult affordability conditions in nearly 40 years.”

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Baseball season hasn’t begun yet, but the Federal Reserve  is dealing with a sweeping curve ball delivered by the sudden failures of three banks.  The first – Silvergate – a California-based lender specializing in the crypto market – didn’t attract much notice. 

But the failure of Silicon Valley Bank – the second largest bank failure ever-- followed quickly by the failure of New York-based Signature Bank (another crypto lender), seriously rattled financial market windows, forcing the Federal government to guarantee all deposits, beyond the maximum of $250,000 per account covered by FDIC insurance. 

The failures of Signature and Silvergate reflected growing fissures in the cryptocurrency sector following the implosion of FTX, a giant cryptocurrency exchange.  But  the failure of Silicon Valley Bank, which provided financial services to technology companies (and held billions of dollars in deposits from them)  underscored the vulnerabilities created by rising interest rates –spurring broader concerns about the health of other businesses and the financial institutions serving them.

As the Biden Administration and bank regulators moved to calm financial markets, Fed officials were preparing for the March 22  meeting of the Federal Open Market Committee (FOMC), the fed’s policy-setting arm.   Before the bank failures, analysts were predicting that the strong February  employment report (employers added more than 300,000 jobs for the month) and other signs of economic strength would lead to another aggressive, half-point rate increase. 

Signs of Strength

After four consecutive three-quarter point increases last year, the Fed took a breath, boosting rates by half-a-point in December and then by a quarter point in February, amid some signs that the rate hikes were having the desired  inflation-tamping effect.  The February  employment report, consumer spending strength, and a somewhat lower but still elevated inflation reading for the month, suggested otherwise.

Hinting at the possibility of another large rate move, Federal Reserve Chairman Jerome Powell noted in a recent speech that “no decision has been made…but if the totality of the data were to indicate that faster tightening is warranted,” he emphasized, “we would be prepared to increase the pace of rate hikes.” 

Up, Down, or Flat?

Then came the bank failures, leading some analysts to predict that to avoid further destabilizing already shaky financial markets, the Fed might not boost rates at all,

"While we agree that more tightening will likely be needed to address the inflation problem if financial stability concerns abate, we think Fed officials are likely to prioritize financial stability for now,” Jan Hatzius, chief economist for Goldman Sachs observed in a note to clients. “Financial  stability is an immediate concern,” he added, “while inflation is a much slower-moving problem.”

Other analysts argued that while the bank failures would be part of the discussion at the upcoming FOMC meeting, they would not affect the inflation outlook, nor alter the Fed’s focus on that issue. 

Competing Goals

What the FOMC will do is still subject to speculation, but there is no question that the bank failures have heightened the tension between the Fed’s primary obligations:  To control inflation and to ensure the stability of the financial system. 

“On the one hand, they are going to have to raise rates: That’s the only tool they have at their disposal,” Subadra Rajappa, head of U.S. rates strategy at Societe Generale, told the New York TimesOn the other, “it’s going to expose the frailty of the system.” While a rising tide is said to lift all boats, Rajappa noted the reverse.  “When the tide runs out, you’re going to see who has been swimming naked.”

Even if the Fed decides not to raise rates next week, most analysts agree that would represent a pause, not an end, to its inflation-fighting efforts.  Absent a significant decline in the inflation rate – which recent statistics don’t reflect and few economic projections anticipate – the Fed will likely feel compelled to push rates higher, reducing the likelihood of the “soft” landing it would like to achieve, and increasing the risks of the recession it would like to avoid.  

Spring Housing Rebound - Unlikely

Responding to hints – or hopes – that inflationary pressures might be easing, mortgage rates dipped in January, bringing some hibernating buyers back into the housing market and spurring hope for a strong rebound in the spring.  But even before the bank failures, mortgage rates had begun to rise again, reaching 6.73 percent in the first week in March – their highest level so far this year. Mortgage applications have declined, as a result, along with buyer interest in touring homes for sale.  

Nearly 80 percent of the prospective buyers responding to a recent survey said they have halted or slowed their home searches; nearly 80 percent cited mortgage rates as their primary concern.

Reflecting the combined impact of higher rates and home prices – though rising more slowly, still above pre-pandemic levels ─ existing home sales declined in January for the twelfth consecutive month, the longest sequence of back-to-back declines the National Association of Realtors has recorded in data going back to 1999.  The annualized January sales pace of 4 million units was the slowest in more than a decade. 

Scant listings, whicih have been problematic for more than a year, remain so, as sellers balk at listing homes in an uncertain market. Redfin reports that new listings the first week in March declined by almost 22 percent, the largest year-over-year decline in the past two months. 

And only a quarter of those listings qualified as “affordable” for the typical U.S. household, according to the Redfin report, which defined as affordable homes on which  estimated monthly payments did not exceed 30 percent of the median income for the county.  Only 9 percent of the listings in Boston met that definition, Redfin found.  Nationally, the report noted, “affordability is at the lowest level in history.”