Review of all things Real Estate: Inflation, mortgage interest rates, and home prices; oh my! Part 2

Okay, in my last article, inflation was discussed which included what inflation is, what causes it and what are the impacts/implications of inflation; good and bad. This article will follow the inflation trail into the woods and address mortgage interest rates and home prices.

Mortgage interest rates are closely related to the 10 year Treasury Bill (T-bill), or put another way, bad news for stocks is often good news for mortgage interest rates. This is because when investors abandon equities, they often flee to bonds therefore the Treasury doesn’t have to pay a lot of interest to attract investors.

Thus, when bond yields fall, mortgage interest rates often do too. Mortgage interest rates were held artificially low when the administration made the decision to buy T-bills in 2020-2022 (quantitative easing) so the bond interest rates were very low and consequently mortgage interest rates were very low (remember 2-3% mortgage interest rates several years ago?).

This action encouraged borrowing (which can have inflationary effects) and put a lot of money into the money supply (also inflationary), but it greatly stimulated the economy which allowed politicians to boast how much better the economy was for the population (who vote).

But as is often said, timing is everything and regrettably the Treasury was late in reducing the purchase of T-bills and inflation started manifesting. When too much money is chasing too few goods and services, the stage is set for an inflationary cycle and prices go up.

In the case of real estate, prices went up dramatically and we witnessed rapidly increasing real estate prices fueled by cheap mortgage money with buyers bidding against each other often above list prices (which were already high due to cheap mortgage money).

In May 2022, the Treasury decided to guard against inflation and start “quantitative tightening” (reduce purchasing T-bills) which along with the Federal Reserve action of raising the prime interest rate to reduce the money supply in the economy were monetary policy actions to combat inflation.

In hindsight, the Treasury’s quantitative tightening was late as was the Fed’s interest rate increases, thus mortgage interest rates went from 2-3% to 7.7% where they are as of the date of this article; all in the course of approximately 16 months.

Not surprisingly, the higher rates stopped the real estate market in its tracks from October 2022 to February 2023 when we got a little relief in the mortgages interest rates and buyers started showing up again. Apparently pent-up demand took over along with the realization that interest rates in the 5-6% ranges were the new normal.

Market activity started up in spring of 2023 then went hot, primarily due to the “golden handcuffs” effect. Sellers weren’t inclined to list/sell their homes and trade their very low interest rates for current levels of mortgage interest rates, hence very limited inventory availability. And we know from the last article that significantly curtailed supply drives up prices as well.

So, we had a perfect storm of artificially low interest rates that stimulated the economy; but the stimulus tools were kept in place too long and we entered an inflationary cycle.

Now the Fed is trying to get ahead of inflation after being reticent to raise the prime rate because the booming economy was popular with the political party in power.

It can be argued however, that the Fed is making corrections to the prime rate too frequently as it can be demonstrated that interest rate corrections may take up to a year to determine the effects of an adjustment; and we have had 11 prime rate adjustments in 12 months. Those anti-inflation controls/efforts are now hurting the real estate market and the consumers.

There was a Peter, Paul and Mary song which contained these words, “When will we ever learn?” It is my humble opinion that government controls and monetary policy are generally ineffectual and result in shortages, supply chain inefficiencies, higher prices, and inflation; when will we ever learn?

I advocate that we should let natural market forces control the outcomes of the real estate and commodities markets; the government should largely leave the markets alone. The government should exercise the same fiscal policy/restraint that we citizens must exercise; pay your bills and don’t spend more than you make. Just sayin’.