The highest mortgage rates in two decades could set off a “severe” price correction that could pull housing prices down by as much as 20%, the Federal Reserve Bank of Dallas warns.
“The possibility of a sharp price correction leading to an economic contraction would further complicate Federal Reserve inflation-fighting efforts,” writes Dallas Fed economist Enrique Martinez-Garcia.
“In the current environment, when housing demand is showing signs of softening, monetary policy needs to carefully thread the needle of bringing inflation down without setting off a downward house-price spiral—a significant housing selloff—that could aggravate an economic downturn,” Martinez-Garcia writes.
The run-up in housing prices during COVID was at a pace not seen since the 1970s, driven by mortgages near a record low. Homebuyers were flush with stimulus cash and eager for more space in the pandemic lockdowns. The housing frenzy got to a point where buyers waived home inspections and appraisals, paid hundreds of thousands of dollars over asking price, and, in some instances, bid sight unseen on homes.
The Federal Reserve, in its effort to control inflation, now at 7.7%, could negatively impact many other areas of the economy outside of real estate, the economist warns.
If home prices were to decline as much as 20%, that “negative wealth effect on aggregate demand would further restrain housing demand—deepening the price correction and setting in motion a negative feedback loop,” Martinez-Garcia warns.
The Fed has increased interest rates six times so far this year, with the last four hikes each being 75 basis points.
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