Why One Fed Official Says Home Prices Will Crash 20% Next Year thumbnail

Why One Fed Official Says Home Prices Will Crash 20% Next Year

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The housing market crisis isn’t over yet. Plenty of experts have speculated as to how high mortgage rates can climb and how far the market has to fall. While there are no definitive answers, many remain pessimistic as to the future of housing in the U.S. They have plenty of reason to be. As InvestorPlace‘s Shrey Dua reports, mortgage rates ended October 2022 by reaching a 20-year high, jumping above 7%. This doesn’t inspire much confidence that markets will stabilize in 2023 and experts are increasingly pessimistic. Enrique Martínez-García, a senior research economist at the Federal Reserve Bank of Dallas recently published a report predicting that the recent rise in mortgage rates will push home prices down 15-20% in the coming year.

Martínez-García describes this take as a “pessimistic scenario.” However, he isn’t the only expert to predict a sinister 2023 for home prices. Pantheon Macroeconomics chief economist Ian Shepherdson issued almost the same prediction less than a month ago, citing the dangerous combination of falling housing demand and spiking interest rates. Like Martínez-García, he sees home prices plunging by up to 20% in 2023, generating further volatility for the housing market.

Home Prices in 2023: What to Expect

In his detailed report, Martínez-García carefully outlines how the housing market arrived at its current precipice. He notes that housing demand quickly outpaced supply during the 2020 Covid-19 pandemic as working from home quickly took over. However, as he noted, problems arose as the belief grew that home prices would continue rising as times shifted. The flooding of the U.S. with stimulus funds also gradually helped push the housing market toward a crash as more Americans rushed to buy. As bubbles inevitably do, they burst and now the air is seeking out of this one as the trends that boosted the housing market in 2020 now push it down. As Martínez-García notes:

“Plausible estimates of the direct impact on housing wealth suggest that a pessimistic scenario—with a real price correction of 15–20 percent—could shave as much as 0.5–0.7 percentage points from real personal consumption expenditures. Such a negative wealth effect on aggregate demand would further restrain housing demand, deepening the price correction and setting in motion a negative feedback loop.”

That said, it isn’t all bad news. For all his pessimism, Martínez-García does not believe a significant housing bust is inevitable. He sees the potential for a soft landing outcome that the Federal Reserve is aiming for if the U.S. can avoid the aforementioned economic downturn. The economist also notes, though, that for this to be achievable, policymakers will need to soothe inflation by easing the stress on buyers and renters. This will mean slowing home prices and rent increases while ensuring that underwater mortgages don’t rise.

The Bottom Line

Is this a challenging outcome? Absolutely but not impossible by any means. Martínez-García also notes that while things are turbulent for home prices now, buyers are still in a better place than they were in 2008. As he states, this could provide the U.S. with “more of a cushion to withstand some of the consequences of a negative wealth effect, were one to materialize.”

Other experts, such as InvestorPlace Senior Investment Analyst Luke Lango, have issued similar takes. Lango recently noted that the trends of massive real estate oversupply and poor loan quality that drove the boom and bust cycle of the early 2000s are not factors in 2022. Even if home prices do fall by as much as Martínez-García is predicting, they stand a better chance of bouncing back.

On the date of publication, Samuel O’Brient did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Samuel O’Brient has been covering financial markets and analyzing economic policy for three-plus years. His areas of expertise involve electric vehicle (EV) stocks, green energy and NFTs. O’Brient loves helping everyone understand the complexities of economics. He is ranked in the top 15% of stock pickers on TipRanks.