Experts say the surge in US house prices is “scary.” What’s going on?
The Federal Reserve started buying around US$40 billion of MBSs each month as part of an asset-purchase program that was designed to help the economy heal from COVID-19 by keeping borrowing costs super-low.
- While buying a house was hardly ever a good option for millennials, the entire process seems to have gotten a little more difficult for the generation.
- The prices for buying homes have increased significantly since the start of the year, with the former Treasury Secretary Lawrence Summers saying that the surge in the United States house prices is “scary.”
- Summers’ biggest concerns involve the current stimulus plan which includes the US Federal Reserve buying mortgage-backed securities (MBS) in order to prevent Americans from going into further debt.
So, what’s a mortgage-backed security?
- An MBS is an investment that is made up of a bundle of home loans bought by governments and larger financial institutions from the banks that originally issued them to homeowners.
- During the pandemic, a lot of homeowners were not able to continue paying their house note or mortgage due to unemployment.
- The money lent by the banks have to be covered, but if the people who agreed to the terms of the loan cannot pay back the money, then who pays the bank back?
- Well, banks tie up these loans into one big lump sum called an MBS and then other investors, such as larger financial institutions or the government, purchase these securities in the hopes of turning a profit.
- The part that Summers is concerned about is how MBSs played a part in the 2007-2008 Financial Crisis that caused millions of Americans to lose their homes.
How is this related to the 2007-2008 Financial Crisis?
- MBSs played a central role in the financial crisis and went on to wipe out trillions of dollars in wealth and damage the world financial markets.
- Banks, big and small, started selling more and more of these MBSs to offset the debt to someone who could take on the financial risk, such as the government. In 2006, housing prices peaked at an all-time high, and it wasn’t long before the housing bubble popped.
- People were no longer able to pay their mortgages since their debts were worth more than their homes.
- Banks then had more MBSs to sell, and many were bought by the then-largest financial institution in America, Lehman Brothers, who thought that holding onto these homeowner’s debts (and therefore their property), would lead to them making more money. The issue is that property prices had already started to fall and Lehman Brothers didn’t have enough cash flow.
- By the time they had tried to sell, property prices had fallen too much, which made their assets hard to sell leading to the largest bank in America at the time to go bankrupt.
- Of course, this is an oversimplification of an incredibly complicated event, but it is widely believed that MBSs were a large domino in the collapse that followed.
Why is the Federal Reserve buying the MBSs if they’re risky?
- MBSs are still bought and sold today, and there is a market for them again simply because people generally pay their mortgages if they can.
- The US government still own a ton of MBSs from the 2007-2008 Financial Crisis, but they have been gradually selling off their current holdings since buying them.
- The current problem is that the Federal Reserve is now buying back MBSs in order to take some of the pressure off of banks.
- The Federal Reserve started buying around US$40 billion of MBSs each month as part of an asset-purchase program that was designed to help the economy heal from COVID-19 by keeping borrowing costs super-low.
- Summers went on to comment on the current projections and his concerns with the market as it proceeds forward.
What are some of Summers’ concerns?
- Summers seems to be most concerned with inflation as the prices for houses is a key indicator that the market is currently inflated.
- “This is scary,” said former Treasury Secretary Summers. “Rising house prices in most people’s common sense of the world represents inflation.”
- He went on to criticize the Federal Reserve for continuing to buy MBSs despite the country currently experiencing rising inflation.
- “I cannot understand why the Federal Reserve, in the face of this, continues to be every month a major buyer of mortgage backed securities,” said Summers “That is the ultimate in pro-cyclical behavior.”
- Even though the former Treasury Secretary has held prestigious titles, Summers has also faced criticism for his part in contributing to “the skyrocketing inequality and climate crisis we’re living with today” according to his peers.
What comes next for the housing market?
- Currently, anything that can be said about the housing market would be entirely speculative, but experts will continue to weigh in and evaluate trends as prices fluctuate.
- As many Americans will know, it isn’t just the homebuyers that are currently facing increased prices for homes, but renters are experiencing a similar problem.
- Data from apartmentlist.com shows that the price for renting has increased by nearly 17% in some locations since the start of the year as people begin leaving their overpriced homes.
- While the rising costs of materials and services may not seem like a big concern, some experts are worried that some Americans will not be prepared for the rising prices.
- “Inflation is the silent killer,” said Brad Lineberger, president of Seaside Wealth Management in Carlsbad, California. “It can erode purchasing power to the point where someone wakes up and can’t live the lifestyle they once did because they can’t afford to.”
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