The Housing Market’s Problem is Speculation, Not Supply


In 2009, something curious was going on with the U.S. housing supply. That year, the Ohio state senate established the Cuyahoga Land Bank—a private, non-profit, government-purposed entity designed to strategically acquire run-down properties and return them to productive use. But when it was first established, the Land Bank found itself not restoring properties, but demolishing them. The process became known as “burying the dead” and each demolished property cost the bank around $7,500.

These properties came from the big banks. Bank of America, Wells Fargo, and J.P. Morgan Chase handed over foreclosed properties they had on their books and could not sell to the Land Bank for demolition. Apart from getting rid of the derelict properties, it was hoped that the demolitions would firm up the price of housing, which at the time was in steep decline.

Judging by the analysis of many housing experts in the lead-up to the financial crisis, it made no sense that the Land Bank ended up with so many unsold properties. At height of the property boom that led to the 2008 financial crisis, news outlets and financial analysts across the country—indeed, across the world—were telling anyone who would listen that the spiraling prices and frantic home-building boom was a response to a supply shortage in the market. Equipped with the tools of an undergraduate economic textbook, these analysts explained to the public that prices rise when demand outstrips supply.

But if the increase in housing prices in the run-up to 2008 were driven by a lack of housing supply, why did prices suddenly crash? And why, in 2009, were states like Ohio establishing Land Banks that would demolish properties that could not be sold? These questions were never answered because they were never asked. After the housing market collapsed, financial markets went into meltdown and the economy fell into deep recession. The public, focused on the unemployment problem and the chaos in the financial markets, forgot all about the prophets of the supply-side that had cheered on the housing mania.

Does this sound familiar? It is precisely where we are today. Once again, housing prices have increased far past any fair value metric. Inflation-adjusted house prices are higher today than they were at the peak of the previous housing mania in March 2006. The same is true of the ratio between house prices and incomes. And once again the prophets of the supply-side are descending from the mountaintop, carrying a stone tablet with a supply and demand graph etched into its face.

Just as in the run-up to 2008, however, it seems far more likely that financialization is driving up the price of property. That is, speculative investors are driving up the price of housing because they view it not as a good to be used, but as an asset that can earn them money—both through the rental yield and future price appreciation. When we examine the evidence, it looks like this housing upcycle is even more obviously driven by speculative investment than the pre-2008 housing market was.

MIAMI, FLORIDA – FEBRUARY 22: A For Sale sign displayed in front of a home on February 22, 2023 in Miami, Florida. US home sales declined in January for the 12th consecutive month as high mortgage rates along with high prices kept people shopping for homes out of the market. It was the weakest home sales activity since 2010.
Joe Readle/Getty Images

Consider mortgages. In the last cycle, annual mortgage growth peaked at 14.4 percent in the first quarter of 2006. The supply-siders could reasonably argue that this represented the peak of demand for housing, although in retrospect we know that many people were simply speculating. This time around, however, annual mortgage growth peaked at only 9.5 percent in the first quarter of 2022. Since we know that house prices are higher now than in the previous cycle, this raises the question: who is bidding up properties?

The answer: cash buyers. In 2022, the number of houses being sold for cash reached 62,000 or one in 10 homes sold. This was the largest amount of cash buyers the market had seen since 1988 and was far higher than at any time in the previous cycle. Some of these cash buyers are individuals who have seen rock-bottom-low interest rates and overvalued stock markets since the initiation of the Federal Reserve’s Quantitative Easing program. Others are investment firms, many of them private equity firms, that take money from pension funds that desperately need higher returns to meet their outgoing payments.

The other force driving this unusual housing bubble is regulation. After the collapse of 2008, the Dodd-Frank Bill put a cap on the amount of risky lending the banks could engage in. But capitalism abhors regulation, and there are always ways to get around it. In the case of the recent increase in housing prices, we have seen the so-called “shadow banking system”—that is, non-bank financial entities—stepping into the space where banks cannot be due to the new regulations. Credit, like life, tends to find a way—a lesson overzealous regulators might learn after the collapse of the present property bubble.

So, when will the bubble burst? Well, it looks like it already has. Rising interest rates have started to impact the market and prices have been declining since April of this year. The last time we saw house prices go into decline was in March 2007. The investment figures are starting to bear this out too. Private residential fixed investment has been falling since the third quarter of last year. The last time we saw private residential fixed investment start to fall was in the third quarter of 2006.

If and when the housing market collapses, the American economy will fall into recession—a real one with widespread construction layoffs, not a mere “technical recession” with two quarters of contracting growth. Depending on where the bodies are buried, a collapse in house prices and purchases may also lead to a financial crisis. At that point, the public will be distracted by the economy and the prophets of the supply side will, as they did in 2008, slip quietly out the back door—a trick the barflies call an “Irish exit.” Let’s hope that this time, policymakers don’t forget them so easily.

Philip Pilkington is a macroeconomist with nearly a decade of experience working in investment markets, he is the author of the book The Reformation in Economics: A Deconstruction and Reconstruction of Economic Theory.

The views expressed in this article are the writer’s own.


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