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US home prices could plunge 20% amid risk of 'deep' housing slide, Fed economist warns

March 2, 2023

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US housing market faces affordability crunch, threat of 'deep' price slide

U.S. home prices could tumble as much as 20% as the highest mortgage rates in two decades threaten to trigger a "deep global housing slide," according to research from the Federal Reserve Bank of Dallas.

The global housing market has become increasingly "frothy" since 2020 as a result of the pandemic boom, the Dallas Fed economists wrote in the analysis published this week. Although house-price growth has recently begun to moderate, there are still risks of a more severe decline.

The economists — Lauren Black and Enrique Martínez-García — pointed to signs of trouble detected in the U.S. and German housing markets that threaten to "pose a vulnerability to the global outlook because of the size of those nations’ economies and significant cross-border financial spillovers."

Some of that peril, they said, stems from an affordability crisis. Signs of diminished affordability in the U.S. have usually preceded global deterioration.

"The possibility of a domino effect, where investors pull out of international housing seeking safety and liquidity elsewhere, also raises concerns of spillovers beyond Germany or the U.S. to the global economy," they added.

For the U.S. housing market to return in line with its fundamentals, the researchers estimated that it would need to experience a 19.5% decline.

Higher mortgage rates threaten to make the price correction even more dramatic.

"While a modest housing correction remains the baseline scenario, the risk that a tighter-than-expected monetary policy may trigger a more-severe price correction in Germany (and the U.S.) cannot be ignored," the researchers said.

During the COVID-19 pandemic, home prices soared at a pace not seen since the 1970s with mortgage rates near a record low. Homebuyers — flush with stimulus cash and eager for more space during the pandemic — flocked to the suburbs. Demand was so strong, and inventory so low, at the height of the market that some buyers waived home inspections and appraisals or paid hundreds of thousands over asking price.

The frenzy came to a halt when the Federal Reserve embarked on the most aggressive interest-rate hike campaign since the 1980s as it tried to slow the economy and crush runaway inflation.

The interest rate-sensitive housing market has so far borne the brunt of tighter monetary policy. Although mortgage rates have fallen from a peak of 7.08% notched in November, they have recently reversed that trend and started to march higher amid interest rate-hike fears. The average rate for a 30-year fixed mortgage climbed to 6.5% this week, according to data from mortgage lender Freddie Mac.

That remains significantly higher than just one year ago, when rates hovered around 3.92%.

Still, even with higher mortgage rates putting home ownership out of reach for millions of Americans, many home prices are still more expensive than they were one year ago. In December, the total value of U.S. houses was still up 6.5% from the same time one year ago.

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