No housing bubble, St. Louis Fed economist says

As some economy watchers spread fears of a possible recession due to the nation’s weak housing market, a top regional economist said that increasing construction costs, rather than another housing bubble, are the major reason that new home prices have outpaced gains in personal income and inflation.

In the Housing Market Perspectives quarterly report, William Emmons, assistant vice president and chief economist of the St. Louis Fed’s Center for Household Financial Stability, said construction costs could be a larger factor in the current housing price trends than either credit conditions or home price expectations.

Another possibility is that the cost of new-home construction increased rapidly, particularly in supply-constrained markets on both coasts, which drove up new home prices. Accordingly, Emmons said we should not blame the recent rise in housing prices nationwide on “bubbly” expectations.

“Construction costs have received less attention than mortgage lending and unrealistic house price expectations, but they appear to be an important part of the recent run-up in house prices.” Emmons said. “In the long run, one would expect construction costs — including the cost of land acquisition and improvement, and of the structures built upon it — to be the primary determinant of new-home prices if local markets for new housing are competitive.”

The key takeaways for the highly watched St. Louis Fed report include:

• Three national house price indexes stood more than 50% above their 2012 troughs in the first quarter of 2019.

• Unlike the housing bubble period before the Great Recession, recent mortgage borrowing and expectations for house price gains have been subdued.

• Construction costs could be a larger factor in house price trends than either credit conditions or house price expectations.

Emmons also noted that some economists believe the housing bubble burst that led to the Great Recession was inflated by sharp increases in the availability and use of mortgage credit, especially by high-risk borrowers. Others suggested widespread expectations of rapid house price growth held by people across the income spectrum has become a self-fulfilling prophecy.

In his earlier quarterly housing report in June, Emmons said that declining home sales and other indicators across all four census regions of the U.S. pointed to a possible recession in late 2019 or early 2020. To view the St. Louis Fed’s latest housing report, click here.