PRESIDENT'S CORNER: Inflation's Hold on the Housing Market

“No doubt business men are greedy; no doubt trade unionists are grasping; and everyone knows that housewives are spendthrifts; but neither the greedy business men nor the grasping trade unionists nor the spendthrift housewives produce inflation…. Inflation is made by government and no one else.”
Milton Friedman

It is hard to explain to clients why the current housing market is so tough and why, for many, a first home purchase is nearly unattainable. Nobel Prize winning economist Milton Friedman explained in 1974, when U.S. inflation was also averaging around 9%, that inflation is the consequence of policy choices that government is encouraged to make. Usually, those policy choices involve exorbitant deficit spending.

Recently, the federal government made $2.6 trillion in funds available to respond to COVID-19 and spent $1.6 trillion of that in 2020 alone. While federal revenue decreased, federal spending grew 45% in 2020. Our country spent 91% more than it collected in revenue, creating a $3.1-trillion deficit in 2020. The money supply of the United States increased nearly $13 trillion dollars since the pandemic began.

Excessive spending causes the demand for goods and services to increase relative to their supply, which, in turn, causes rising prices. Factor in the supply chain disruptions we experienced during the pandemic, and now you have even higher prices resulting from the reduced supply of goods and services.

Tough decisions during a crisis are difficult to make, and judging government response to the pandemic is not the point. However, we must understand the consequences of decisions—good or bad—because those decisions always have economic consequences.

Excessive spending often results in destructive inflation, which is typically combated, not by reduced spending (who wants that?), but by higher interest rates. Higher interest rates drive up mortgage rates, making housing less affordable. Actually, everything becomes less affordable.

Rising interest rates have made the costs of financing and construction so high that developers have less incentive to build new housing. While the cost of lumber has come down dramatically, lumber still costs 22% more than pre-pandemic. In 2022, 976,000 building permits for single-family housing units were issued in the US. This is fewer than in 2021, and considerably less than its peak of 1.68 million building permits in 2005.

Now exceeding 7%, mortgage rates are double what they were pre-pandemic. That means fewer and fewer Americans can afford to buy a home, let alone find one due to low inventory. NAR reports that total housing inventory registered at the end of June 2023 was 1.08 million units, down 13.6% from one year ago. According to NAR Chief Economist Lawrence Yun, “Existing-home sales activity is down sizably due to the current supply being roughly half of the level of 2019.”

Even though rents are skyrocketing, landlords’ profit margins are down because costs have also skyrocketed. Electricity prices surged 14% in 2022. In New York, Con Edison gas and electricity bills may more than double in the next two years due to a newly approved rate hike by the state’s top public utility regulator. This month, Con Ed will spike utility rates across New York City by 9% as part of a three-year rate plan approved by the New York State Public Service Commission. Property insurance premiums also jumped in 49 states in 2022, with premiums rising an average 4.9%. Rates are predicted to rise another 9% in 2023.

These costs don’t just affect landlords, they affect every homeowner.

NAR’s affordability index measures whether or not a typical family could qualify for a mortgage loan on a typical home. Based on the most recent monthly price and income data from June 2023, NAR’s data shows that a typical family does not earn enough income to qualify for a mortgage loan on a typical home. In fact, affordability has decreased substantially by double digits since 2019.

It is not coincidental that record low housing inventory and record unaffordability rates are wreaking havoc and uncertainty in the housing market at the same time we are suffering from record high inflation rates. Economics 101 teaches us that these consequences are the result of inflation. Inflation, in turn, is the result of excessive government deficit spending, which is a policy choice that government makes. Of course, there are plenty of other foolish policy choices that impact affordability and inventory too (i.e., letting NY’s 421a program expire will have its own impact on housing supply and affordability).

As a society, we have condoned and encouraged our government to excessively and irresponsibly spend our way out of every problem. As Milton Friedman argues, society imposes political pressures upon government to take these actions and, at some level, the resulting inflation is just a manifestation of fundamental social issues.

When our clients ask us why they can’t afford to buy a new home, perhaps the best explanation is that our society is simply placing “excessive demands” on our government that we can no longer afford. As a trade association, perhaps it is our duty, on behalf of our members and our clients and customers, to advocate for more responsible fiscal policies and for better ways of dealing with our social problems.