Good Intentions Go Awry: Record Low Mortgage Rates Caused This Housing Impasse

If the road to hell is paved with good intentions, then the road to economic purgatory is paved with, well, good intentions and easy money. We are seeing a scenario of unintended consequences play out today via the distorted supply-demand imbalance in the U.S. housing market that shows no sign of letting up and which could persist for quite a while longer. This distortion is mostly the result of COVID-era policy actions and responses to them that juiced the housing market in 2020-2021 but are now bogging it down, as potential sellers cling to their homes and super cheap mortgages while unyielding home prices remain out of reach for most aspiring home buyers given the spike in mortgage rates. Supply-demand imbalances in almost any free market are resolved via price adjustments, but that is not happening with home prices, as there is little incentive for prospective sellers to reduce asking prices and surrender their cheap mortgages in this sputtering market. They would rather stay put until “normal conditions” return — though there was nothing normal about the COVID-era housing market. Consequently, existing-home sale transactions have slowed dramatically this year.

The Federal Reserve’s response during the COVID-19 pandemic was multifaceted but featured an all-out effort to lower interest rates to all-time lows via a reduction in its targeted Fed Funds rate to 25 bps from March 2020 through March 2022, as well as aggressive open-market purchases of Treasury and mortgage-backed securities that caused the size of its balance sheet to double within 18 months while pushing the nominal 10-year Treasury note yield towards 0.5% at its nadir in August 2020. Other market rates of interest followed along, as yields on BBB-rated corporate bonds approached 3.0%, and a 30-year fixed-rate home mortgage dipped below 3.0% in that time frame. For borrowers it was nirvana, but for savers it was hellish. Near-zero rates of interest combined with torrents of financial liquidity provided during the COVID period unleashed all sorts of speculative (often excessive) investment activity, including rampant day-trading in stocks, bubbly tech company valuations, NFTs (remember them?), cryptocurrencies and, yes, housing.

Sales of existing homes hit 6.1 million units in 2021, the largest annual total since the peak of the housing bubble in 2005-2006, while average home prices nationally soared 30% cumulatively in 2020-2021. Record low mortgage rates were supposed to make homes more affordable for buyers but instead drove up home prices to record highs and laid the groundwork for the current environment. 

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