Faltering housing market reflects rising interest rates

The most expensive purchases you ever buy in your life are your home and car. Most of us buy both items with borrowed money so changes in the interest rate, i.e., the cost of money, have the most immediate impact on those two categories. So far, autos are holding up because dealers have no inventory.

The Federal Reserve Board has two primary responsibilities: full employment and controlling inflation. It has two blunt tools with which to do those jobs: raising and lowering interest rates and expanding or reducing its own balance sheet. For more than a decade, first to fight the Great Recession and then the economic impact of COVID, the Fed pushed interest rates to near zero. In 2008, Ben Bernanke wanted to restore individual balance sheets by restoring the value of our homes and our stock investments both of which had collapsed. Low rates helped both.

Since 2020 with the arrival of the pandemic, the Fed began pumping $120 billion into the economy each and every month. By last fall, its own balance sheet exceeded $8 trillion.In September, it will start to reduce its holdings by $95 billion per month.

When the Fed recently shifted its gears to rein in the economy, it gingerly began raising interest rates by first a timid 0.25%, then 0.50% and then two increases of 0.75%. That brought the current target range to 2.25-2.50%. Neither we nor the Fed knows yet what interest rate level will bring inflation down to the desired 2% range. However, the impact of higher rates has already begun, especially regarding home purchases and prices. No longer are buyers engaged in bidding wars and finding themselves going far over their intended budget.

Homebuilders just reported new home cancellation rates of 17.6%, double the April rate. Across the nation, 63,000 deals fell through in the latest period with Texas at 27% followed by California at 23%. That rate was 13% in Florida. Some deals fell apart because the buyers were unable to qualify for the new higher mortgage payments. However, many have just walked away in fear that they will be buying at the peak and regret it for years to come.

As for existing home transactions, Florida has seen some of the highest cancellations rates in the country. Perhaps that is a reflection of the rapid price increases in the state as people moved here during the COVID migration from north to south. Jacksonville saw the highest rate of deals falling through of 29.3% (800 deals) that were not completed. CNBC's Diana Olick observes that there remains an unfilled demand for about 1 million homes that has developed over the last decade. That may explain why the overall rate of housing starts has now fallen from a 1.664 million annual rate to 1.559 million now, a drop of 6.3% from a year ago but nothing more precipitous.

Nobody expects this to be at all like the housing collapse of 2008-09 that saw several Wall Street firms go out of business. Thanks to Dodd Frank regulatory reforms, banks are no longer making loans that are not likely to ever be repaid on marginal properties at peak prices. However, it is not a good time to be trying to flip older houses with the idea of buying a fixer upper in need of a refresh, replacing the kitchen and bathrooms and flipping it to someone else at a higher price.

Joan Lappin CFA has been called an "investment guru" by Business Week and a "top manager" by the Wall Street Journal. The Sarasota resident founded Gramercy Capital Management, a registered investment adviser, in 1986. Email [email protected]. Follow her on twitter: @joanlappin. Her past columns appear at heraldtribune.com/business/columns.

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Joan Lappin

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