By Jeanette Garretty, Chief Economist
January 14, 2025 – Economists, lenders and policy analysts are given to talking about the US housing market in notably clinical terms. A blizzard of monthly data on, for example, “housing starts,” “building permits,” and “new home sales” (from the US Census Bureau), “existing home sales” (from the National Association of Realtors), “the House Price Index” (from Federal Housing Finance Agency), and the MBA Purchase Index (from the Mortgage Bankers Association) attempt to provide insight into activity in this highly visible economic sector. The market is regularly parsed into “owner-occupied” housing, “multi-family properties,” and “income-producing real estate” to better understand household spending behaviors and underlying financial risks. Mortgage rates and housing affordability measures are key topics at think-tank seminars and everyday cocktail parties.
It should not be surprising that a market of such economic size and power should be so scrutinized. The annual expenditure on the construction, purchase, and maintenance of residential buildings, known as “residential fixed investment,” historically has an approximate 5% share of GDP. However, when this figure is combined with the almost 18% of personal consumption spending devoted to “housing services” – rent paid by tenants and the equivalent rent that would be paid by homeowners if they were renting their house– it becomes apparent that housing represents at least 15% of annual economic activity. If one further widens the focus on consumption spending related to housing to include appliances, utilities, HOA fees, etc., assigning the housing market responsibility for as much as 20% of GDP is not out of the question.

And yet . . . how much is really understood about the housing sector? There are regional differences that national statistics may not adequately address, and the differentiated nature of the market is well-captured by the old adage about location, location, location. Attempts to remedy a glaring and stubborn undersupply of housing that would make the market more affordable have been frustrated and frustrating in numerous regions. The Federal Reserve seems continuously surprised that rent increases have not decelerated as anticipated, sustaining an upward pressure on major measures of inflation. Political failure to tackle the high cost and lack of availability of housing has been cited as one of the factors influencing the results of US elections, and yet policy responses tend to be fragmented and unsupported by necessary data.
Furthermore, the very decision to make a residential purchase — what is more normally called “buying a home”—seems to be increasingly subject to different and rapidly changing price considerations. Specifically, the rise in the cost and the decline in the availability of home insurance has become a major problem for homebuyers, complicating a straightforward response to the normal market variables of mortgage rates and home prices. In situations where a home buyer opts to self-finance due to home insurance difficulties, mortgage rates are not even a consideration, though interest rates may still be a factor in situations of using a line of credit or as an opportunity cost concept for the liquidity being deployed. Even more problematic is the obvious need to correctly evaluate the insurance liability now being assumed by the homebuyer against some future theoretical calamity – a task that is sadly anything but obvious to many people.

If the supply of homes and the demand for homes were adequately balanced and prices were therefore in some sort of equilibrium, one would expect home prices to fall to accommodate the increased cost of owning a home imposed by insurance costs escalated by natural disasters. One could easily imagine a prospective homebuyer making an offer to the seller that is below the asking price by the exceptional cost of the insurance. As already mentioned, however, the well-documented imbalance between population growth and the growth of the housing stock in the United States implies that higher costs may simply price some people out of the market (as is the case now) and reduce the amount of excess demand, while shifting even more of household budgets into housing.

Note that Zillow now estimates that there is a 4.5 million unit shortage of housing in the United States (2021-2022 data analyzed in June 2024), and the latest housing starts figures show new building tracking at the lowest level since 2019-2020. Considerable building activity was lost in the run-up to and the resolution of the Financial Crisis of 2008, and the recovery has stalled as interest rates and other costs increased in recent years.

People are by and large, rational economic actors. They will make sensible decisions based on information transformed into perceived prices and benefits; they are rational, but their rationale is their own and is not always well-measured by observers (like economists). Housing has long been recognized as a special expenditure, a necessity providing shelter, a consumer good that is both aspirational and reflective of oneself, and an investment that is the largest single investment of most US households. Despite the fact that it is called “Residential Fixed Investment”, analyzing the home purchase market through the same lens as the capital goods market (“Nonresidential Fixed Investment”) will seldom prove wise. A house is not a home, and a home is much that cannot be quantified: memories, refuge, freedom, personal control in an impersonal world.
The special nature and importance of the housing market also has long been a foundational principle of US socio-economic policy. Much to the irritation of many economists, home buying is a highly subsidized activity: mortgage debt
deductibility, mortgage interest rate subsidies, and down-payment subsidies are at the core of the tax code and a fundamental reason for the existence of the FHA, Fannie Mae, and Freddie Mac. As stated in a 2011 paper published by the Federal Reserve Bank of Cleveland, “The overwhelming majority of government programs targeting individuals in the housing market are intended to encourage borrowing by lowering interest costs.” How does it work then if the mortgage market is undermined by the inability to afford – or obtain—insurance? Programs such as the California FAIR plan are a logical development, but they will require considerable expansion if they are to be the newest player in the long history of government support for housing. The National Flood Insurance Program is a longer-standing example of a government policy response to an insurance “problem”, which the insurance industry may not perceive as a problem at all. Andy Neal, an AON executive who was chief actuary of the National Flood Insurance Program, recently told New York Times columnist Peter Coy, “Insurance ‘is the last economic signal’ that steers where people choose to develop and live.” It is not clear how well politicians and individuals accept the assignment of this particular role for the insurance industry.
One further wonders what is happening behind closed doors in the Asset & Liability committee meetings of major home lenders, for which home mortgage lending is a major profit center as well as a source of considerable risk.
In a week of listening to the news from the horrible fires in Los Angeles, no one was heard to say, “Oh well, that’s one investment gone bad.” Or “it’s just a house.” Instead, the news was full of stories about family, dreams, special moments and valued friends, beautiful sunsets, stunning views, incomparable peace and joy. These things have immeasurable value. There will be great difficulties in rebuilding, and not all will be rebuilt, but homes are not readily taken away, even by catastrophic fire. If the heart is still there, the home will follow. Godspeed to everyone who lost so much. May their hearts find a home sooner rather than later.
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