Why a market correction in the U.S. could have global effects
A new report by the Dallas Federal Reserve said that "frothiness" in the real estate marketplace could lead to a "deep global housing slide."
- The report focused on run-ups in housing prices in the U.S. and Germany, driven by the pandemic.
- While modest housing corrections are underway in both nations, there is the possibility of a “more severe” price correction in the near future.
Dallas Federal Reserve researchers are warning that the housing boom in the U.S., which has been followed by an affordability crisis, could have global consequences.
In a report released Tuesday, analyst Lauren Black and economist Enrique Martinez-Garcia concluded that "while house-price growth has recently begun to moderate — or in some countries to decline — the risk of a deep global housing slide persists."
Their research focused on housing affordability in the U.S. and Germany, which both experienced overheated marketplaces that accelerated during the pandemic.
Residential real estate in both countries is showing signs of "frothiness" — the kind of brew that could lead to a bubble — based on widespread perceptions that strong price increases will continue unabated in the housing market, they said.
"The bubble hypothesis merits attention," the authors wrote. A housing or real estate bubble is a run-up in prices driven by demand, investment and "exuberant" spending.
"Affordability crises arise often from unsustainable and widespread exuberant behavior, data suggest," Black and Martinez-Garcia wrote. Such exuberance has been seen in the credit-fueled housing booms that have occurred in previous housing cycles since the 1970s — sometimes followed by "severe corrections."
A major housing correction in either the U.S. or Germany could trigger a global housing slide because of the relative size of their economies, the authors noted. "Signs of diminished affordability in the U.S. have usually preceded global deterioration," they wrote.
While modest housing corrections are underway in both nations, the authors said there is the possibility of a more severe price correction.
For the U.S. housing market to "return to its fundamentals," they estimated that a 19.5% correction in the so-called price-to-rent ratio is necessary. The price-to-rent ratio measures the profitability of housing as an investment opportunity.
The authors noted that tighter-than-expected monetary policy for fighting inflation often affects the housing sector more than other areas of the economy.
"Warning signs of froth in international housing have been apparent since 2021. Germany's housing market, much like the U.S., is at a crossroads," Black and Martinez-Garcia concluded.