Originally published in the Financial Times on January 12, 2023.

Spare a thought for the American first-time homebuyer, for whom things have rarely looked so grim.

US home prices rose 40 per cent during the pandemic. Mortgage rates haven’t been this high in 15 years. Wages are higher, but not nearly enough to compensate for these factors. You can see the challenges starkly in the Atlanta Fed’s affordability tracker:

Unsurprisingly, this has resulted in US home sales falling off a cliff. The drop has been more rapid than even the decline in 2007-08:

So far, in these respects, this looks like a classic rapid correction from an overheated market. As Jay Powell recently described it at a Brookings event:

“ . . . You really had a housing bubble. You had housing prices going up at very unsustainable levels and overheating and that kind of thing. So now, now the housing market’s going to go through the other side of that.”

But here’s where things get a bit weird: the bubble is clearly deflating, if not popping, through activity — homes are changing hands at the slowest pace since 2012. But prices have hardly budged.

From the peak in June, prices are down only 1 per cent — and they are still up 10 per cent from a year ago.

This is obviously bad news for prospective home buyers, but also for the Fed: higher home prices push up rental prices and the imputed cost of owning a home (“owner-equivalent rent”). Together, these constitute more than 40 per cent of core CPI attributed to shelter costs.

Real estate folks think supply explains the surprisingly modest price drop. For one, there is a lack of housing inventory. This is partly a long run trend but is getting worse. Given population growth and household formation the US was short of 3.8mn housing units by late 2020, according to Freddie Mac’s chief economist Sam Khater.

This secular lack of homes is being exacerbated by cyclical factors. Since you can’t take your mortgage with you, nobody wants to move and reset their loans at much higher rates. Would-be sellers are therefore sitting on the sidelines. From the WSJ:

“I like to call it the ‘golden handcuffs’ of mortgage rates,” said Odeta Kushi, deputy chief economist at First American Financial Corp. “You’ve got existing homeowners who are sitting on these rock-bottom rates, and what is their financial incentive to move and lock into a rate that’s potentially as much as 3 percentage points higher than what they’ve locked into?”

Fannie Mae estimates that at the end of October, more than 80 per cent of all borrowers had a mortgage rate that was at least 200 basis points below market rates, “by far the largest share in decades”.

Taylor Marr, deputy chief economist at real estate listings service Redfin, reckons that mortgage rates will help depress home sales down to the lowest since 2011:

“We expect about 16% fewer existing home sales in 2023 than 2022, landing at 4.3 million, with would-be buyers pressing pause due mostly to affordability challenges including high mortgage rates, still-high home prices, persistent inflation and a potential recession. People will only move if they need to.”

So homeowners are not opting to sell. But they are not being forced out, either.

In the pandemic housing boom, lending standards never dropped to 2008 levels — today’s average homeowner is of much higher quality and sitting on a bigger equity cushion. According to the Mortgage Bankers Association, less than 10 per cent of new mortgages are adjustable rate mortgages. Mortgage resets, the powder keg that set off the 2008 crisis, therefore won’t be a major factor.

Here’s Joel Kan, the Mortgage Bankers Association’s deputy chief economist, in Yahoo Finance:

“This is a very different environment than the products prevalent prior to the Great Financial Crisis,” Kan says. “The credit quality of borrowers is stronger, and the types of ARMs that are available now are of much lower risk, without the same potential for near-term payment shock.”

On the demand side, lower affordability is decreasing demand, but maybe not as much as one would expect. Household balance sheets are in decent shape, and unemployment is (for now) low. Home builders are also helping foot the cost of more expensive mortgages through buy downs.

The result is a stalemate: would-be buyers are deterred by high prices and financing costs, and would-be sellers have little incentive to sell at lower prices, or to sell at all.

So where do we go from here? Forecasts are all over the map — KPMG is calling for a 20 per cent fall, and Goldman Sachs for a 7.5 per cent drop, while the Mortgage Bankers Association and the National Association of Realtors think prices will actually rise, though not by much.

Calling for anything but much lower prices after the recent boom in home prices and soaring mortgage rates does sound a bit insane. But in the 1970s and 1980s — the last time the Fed was ratcheting up rates to deal with inflation — nominal prices didn’t actually fall.

So if history repeats itself, it could eventually be lower mortgage rates alone — not lower prices — that eventually puts an end to the stalemate between buyers and sellers.