“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years,” wise words from Warren Buffett remind us of the importance of mindful investing, especially in today’s economic climate where asset prices are soaring to concerning heights.
Currently, stock values are approaching historical highs. Investing in even top-tier companies at this moment could lead to prolonged periods of stagnation or losses, as the inflated prices create significant risks.
The absurdity of today’s valuations has been highlighted repeatedly, with metrics like Shiller’s Cyclically Adjusted Price Earnings (CAPE) ratio and the Buffett indicator illustrating that overall stock prices are vastly overstated. This reality seems to be largely overlooked in the current discourse.
Moreover, treasury yields, which move inversely to prices, are languishing at the low end of a decades-long credit cycle. Once these yields begin to rise, they could do so for the next 20 years, contributing to a downward adjustment in asset prices alongside increasing borrowing costs.
This trend has taken a long time to develop, but its arrival is imminent. As the economy still grapples with cheap credit and inflated asset values, the transition may prove to be a challenging one.
Questionable House Prices
House prices are particularly sensitive to fluctuations in borrowing costs. A mere 3 percent increase in 30-year mortgage rates can add an additional $500 to the monthly mortgage payment for a typical home. Therefore, for housing prices to align with rising borrowing costs, a decline is necessary.
House prices have significantly benefited from the Federal Reserve’s zero-interest-rate policy and have seen a sharp increase over the past few years as a result. Although they have not reached the unsustainable peaks observed during the housing bubble in the mid-2000s, from early 2012, the median housing price in the U.S. has risen by over 20 percent, with even larger increases in specific areas.
However, this surge in house prices appears dubious. The growth in asset values has not been matched by corresponding increases in wages or living standards. While per capita incomes increase by only 3.1 percent and wages by 2.2 percent, house prices are escalating at a considerably faster pace. This divergence has largely been fueled by cheap credit.
Consequently, median house prices have become increasingly unaffordable for individuals with median incomes. This may explain why the U.S. homeownership rate has plummeted to a 20-year low. Ironically, this decrease in homeownership has resulted in a rise in rental demand and, consequently, rental prices. So, what does this imply?
Why Are Residential Rental Prices Skyrocketing?
The economic distortions stemming from the Fed’s monetary policies are making a significant impact on the rental market. In fact, the situation has been pushed to such extremes that, according to the National Low-Income Housing Coalition, “A worker would need to earn $19.35 per hour—almost three times the current federal minimum wage of $7.25—to afford a basic two-bedroom unit. A one-bedroom unit requires a wage of at least $15.50 an hour.”
Yet, this is just the tip of the iceberg—certain states fare even worse. In Hawaii, Washington, D.C., California, New York, and New Jersey, rents are so high that workers need to earn over $25 per hour, with Hawaii’s figure soaring to nearly $32 per hour.
Proposed remedies for these exorbitant rents often miss the point. Instead of addressing the underlying issues caused by the Fed’s financial manipulations, the common response is to advocate for higher minimum wages. The expectation seems to be that raising wages will somehow align the productivity of the economy with inflated rental prices.
However, raising minimum wages will not resolve the housing affordability crisis. Rather, it may lead to job scarcity and further edge the economy toward instability.
With fewer jobs and rising rent prices, living standards are set to decline. Unlike the 2008 financial crisis, which was met with applause for the Fed’s actions, the next downturn could see a much harsher response. Ideally, this would lead to a renewed emphasis on sound monetary policies and market-based pricing for credit.
Only then can housing and rental prices align more naturally with economic realities, bringing equity and fairness back into the housing market.
Sincerely,
MN Gordon
for Economic Prism
Return from Why Residential Rental Prices are off their Rocker to Economic Prism
