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U.S. navigating pandemic ‘housing bubble,’ Fed chairman says. Will it pop or ‘deflate?’

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Federal Reserve Chairman Jerome Powell speaks at a news conference in Washington.

Federal Reserve Chairman Jerome Powell speaks at a news conference following a Federal Open Market Committee meeting, Wednesday, Nov. 2, 2022, in Washington. While answering audience questions at a Brookings Institution event this week, Powell told the crowd the dramatic rise in home prices in 2020, 2021 and part of 2022 was a “housing bubble.”

Patrick Semansky, Associated Press

He has said the U.S. housing market needed a “difficult correction” and a “reset” to bring better “balance” to a market that had enjoyed runaway price growth and demand during the pandemic frenzy — but this week Federal Reserve Chairman Jerome Powell used a stronger word to describe the state of the nation’s housing market.

“Bubble.”

While answering audience questions at a Brookings Institution event Tuesday, Powell told the crowd the dramatic rise in home prices in 2020, 2021 and part of 2022 was a “housing bubble.”

“Coming out of the pandemic, rates were very low. People wanted to buy houses. They wanted to get out of the, you know, the cities and buy houses in the suburbs because of COVID. And so you really had a housing bubble,” he said. “You had housing prices going up at very unsustainable levels and overheating and that kind of thing.”

At the same time, the nation is also grappling with a long-term housing shortage that helped fuel demand.

“So now, the housing market’s going to go through the other side of that and hopefully come out in a better place between supply and demand,” Powell said. “But none of this really affects the longer run issue, which is that we, you know, it’s we’ve got a built-up country and it’s hard to get zoning. It’s hard to get housing built in sufficient quantities to meet the public’s demand.”

Throughout the unprecedented surge in home sales and home prices — which has especially impacted housing markets in Mountain West states including Idaho and Utah — housing experts have warned against drawing too many parallels to the 2005 housing bubble, fueled largely by risky lending practices that propped up demand. When the subprime mortgage crisis caught up to big banks, that bubble popped and sent the global economy spiraling into the Great Recession.

Today, economists continue to say they don’t see dramatic implications for the national economy as the U.S. housing market shifts under relentless pressure from the Federal Reserve’s fight with inflation, its aggressive interest rate hikes, which has indirectly resulted in mortgage rates that have hovered around 6% to 7%.

However, economists have warned the U.S. housing prices were growing detached from market fundamentals. Earlier this year, before prices peaked in May, researchers at the Federal Reserve Bank of Dallas wrote a blog post saying they were seeing signs of a bubble brewing — just not the same type of housing bubble that preceded the 2007 and 2008 financial crisis.

“There is growing concern that U.S. house prices are again becoming unhinged from fundamentals,” researchers wrote, though they argued “the underlying causes of the run-up differ from those during the last housing boom.” Rapid price increase alone “does not in itself signal a bubble” but home prices can “diverge from market fundamentals when there is widespread belief that today’s robust price increases will continue.” In other words, “exuberance” or a “fear of missing out” on the pandemic housing frenzy stoked concerns about a bubble forming.

Now, after months of higher interest rates, the market’s hit a tipping point. Powell’s comments this week also came after another article published Nov. 15 by the Federal Reserve Bank of Dallas that urged policymakers to “deflate the bubble rather than burst it,” as Fortune put it.

The title of the article? “Skimming U.S. Housing Froth a Delicate, Daunting Task.” It’s author, Enrique Martínez-García, a senior research economist, also used the term “housing bubble” and wrote the “pandemic surge before summer 2022 exhibited widening symptoms of a FOMO (fear of missing out) -driven bubble, one that extends beyond the U.S.”

As housing demand softens, Martínez-García wrote monetary policy makers need to “carefully thread the needle of bringing inflation down without setting off a downward house-price spiral — a significant housing sell-off — that could aggravate an economic downturn. Increasing mortgage rates, which follow from higher Fed policy rates, reduce the risk of prolonging the house price boom.”

“A gradual unwinding of the pandemic housing excesses can occur if policymakers can quell inflation without putting buyers under too much stress and can slow house price and rent increases while keeping underwater mortgages (housing worth less than what is owed) from rising,” Martínez-García continued.

American households and banks are in “better shape” than the 2000s boom and bust, he wrote, which could likely offer more of a “cushion to withstand” some of the consequences. “Cooling” buyer’s expectations is key to “shifting housing prices toward a more sustainable path and avoiding the peril of a disorderly market correction.”

So is a housing crash coming?

“A severe housing bust from the frothy pandemic run-up isn’t inevitable,” Martínez-García wrote. “Although the situation is challenging, there remains a window of opportunity to deflate the housing bubble while achieving the Fed’s preferred outcome of a soft landing. This is more likely to happen if the worst-case scenario of a price-correction-induced economic downturn can be avoided.”