Rising housing costs – offset by bank reserves, strong household balance sheets – not a financial stability threat yet, Fed governor asserts

The sharp and ongoing recent increase in home prices poses less risk to financial stability than similar increases in the mid-2000s, a Federal Reserve Board governor indicated Thursday.

In a speech to a conference titled “Recent Fiscal and Monetary Policy: Implications for U.S. and Israeli Real Estate Markets,” Gov. Christopher Waller said he is keeping an eye on the impact of the rise in home prices – which have increased a cumulative 35% since the start of the coronavirus crisis in spring 2020 – on financial stability. However, he indicated that at least for the moment, stability is under less pressure than in past home price increase periods.

“My short answer is that unlike the housing bubble and crash of mid 2000s, the recent increase seems to be sustained by the substantive supply and demand issues I have detailed – not by excessive leverage, looser underwriting standards, or financial speculation,” he said. “In fact, mortgage borrowers entered the pandemic with stronger balance sheets than in the mid 2000s and are therefore better prepared to handle a drop in home prices than they were in the last housing downturn.”

He also noted that large banks are substantially more resilient today than they were two decades ago. “In last year’s stress test, which featured a severe global recession that included a decline in home prices of over 20%, we projected the largest banks could collectively maintain capital ratios at more than double their minimum requirements – even after withstanding more than $470 billion in losses,” Waller said.

The Fed governor said he was hopeful that pressures and factors pushing up home prices and rents would start to ease over the next year. “The level of new housing units completed in 2021 was higher than at any point since 2007,” he said. “The demand for extra space at home might level off, or even reverse if people start to spend more time away from home again as the pandemic eases. That said, input prices continue to rise, with lumber prices increasing past their eye-popping 2020 peak, even with much more supply.”

Waller said he expects that housing costs as a share of expenses for households will continue to rise over time from their 35% of household budgets in 2019. “With housing costs gaining an ever-larger weight in the inflation Americans experience, I will be looking even more closely at real estate to judge the appropriate stance of monetary policy,” he said.

Fed Gov. Christopher J. Waller: “The Red Hot Housing Market: the Role of Policy and Implications for Housing Affordability”