The Fed’s mismanagement of inflation has been devasting to the American people. They were too late to raise rates and stop Quantitative Tightening in 2022 even though all the conditions were set for hyperinflation. The Fed knew of expanding Federal spending, rising money supply (M2), and supply shortages created from the Pandemic and the Russia Ukraine War. All these are basic conditions for higher prices that a first-year economic student would understand. (see the Background Information section below for more details)
Now the second major mistake by the Fed is ahead for our fellow Americans. The policy of higher rates for longer is having a significant impact on the current cost of housing when you consider interest costs. Additionally, the lack of capital going towards future housing development will create a bigger shortage of housing supply in 2025 and 2026 similar to the housing shortage created after the 2008 Housing Crisis.
The Fed may be structurally embedding housing inflation into the cost of living through 2027 if they don’t immediately change policy.
In the chart below you will see that housing costs have inflated 4.7% annually since 2015, which is well above the Fed’s 2% inflation target. If you include the cost of interest, housing is inflating at an annual rate of over 9% since 2015 and is hyperinflating at the annual rate of 24.5% under the Biden administration given the rapid increase in mortgage rates. CPI does not include the cost of financing your home.
You are fortunate if you locked in your mortgage rate in 2020-2021 or own your home outright. Unfortunately, this is not the case for many.
This recent surge in interest inflation has made its way into Owners' Equivalent Rent (Key housing inflation measure in CPI) which is up 5.2% annually under Biden versus 3.2% under Trump. Asking rents for apartments are up 9.7% annually under Biden versus 6.6% under Trump. Home ownership is no longer affordable for the average family, and we are moving to a population of renters.
With home ownership becoming less affordable the reliance on apartments will become more important to control housing costs. The good news is there is a lot of apartment supply coming on the market this year which will help rent inflation in the short term. National rents have been moderating over the last 6 months.
Unfortunately, the higher for longer policy has all but stopped construction loans for new apartment developments. I know of several developers that have stopped all future developments and are now land banking deals.
Regional banks that are the primary financing source for developers are under stress and are significantly limiting new loans as they contend with capital structure issues. This happened after the Housing Crisis in 2008 and is now repeating itself. See the chart below for housing starts for multifamily projects.
What Can Powell or Biden Do?
1) Create a lending facility to lower interest rates for middle/lower income home buyers.
2) Create a funding facility for new developers of apartments/affordable housing.
3) Renew QOZ tax incentives for apartment developments.
(disclosure – I am invested in several QOZ funds)
Background Information
Back in June 2020 Powell stated that the Fed is not even thinking about thinking about raising interest rates. This was right before the significant rise in inflation. As I have maintained for years, the Fed looks in the rearview mirror for data, yet their policy actions have a long and variable lag (12-18 months). Clearly a recipe for slow to act and slow to respond.
As inflation spiked through 2021 and early 2022 the Fed sat on their hands. They didn’t start to raise rates until April 2022 and didn’t end Quantitative Tightening (QE) until March of 2022. CPI was already over 8%.
Growth in Money Supply
In fairness the supply shock from both the pandemic and the Russia/Ukraine war played a role in inflation but the Fed downplayed the impact of the unprecedented increase that M2 was playing. Too much money chasing too few goods poured gasoline on inflation.
Insane Federal Spending
To add more fuel to the fire the money spent by Trump Administration to “save the economy” was insane and was not targeted.
For Example - There were restaurants that closed that got money – Good. There were drive thru restaurants that had tremendous sales and they got the same money – Bad.
For Example - There were fellow Americans out of work that got money – Good. There were fellow Americans that worked from home with lower cost since they didn’t have to commute, and they got the same money – Bad.
Then Biden follows this spending with more spending with money we don’t have.
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