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The Federal Reserve is making housing more unaffordable and fueling inflation - Something's gotta give soon

By most traditional measures, “housing” accounts for 15%-18% of our national GDP. However, when one takes into account all of the secondary and tertiary economic impacts (“multiplier effects") on other industries and services that make up the extended housing industry ecosystem and its ancillary and subordinate industries and businesses, it is arguable that the housing industry is the largest single contributor to our national economy.

These other industries and businesses include everything from natural resource extraction, materials and products manufacturing, and transportation to wholesale and retail sales of furniture, appliances, household goods and furnishings, landscaping, and thousands of other household things that are sold at Home Depot that result from new “household formation,” plus the economic activity in supporting businesses like banking, brokerage, housing stocks and bonds, and derivatives trading.

That considered, the level of interest rates set by the U.S. Federal Reserve and the methods it uses to measure what is going on in our economy really matter. High interest rates push the prices of everything in the housing industry's financing, supply chain, and greater ecosystem higher, increasing the overall inflation rate. And when it becomes obvious that the methods they’re using no longer accurately reflecting our economy, things must change.

To explain what this means, let’s look at current data.

The first chart, by BCA Research and RIA, shows the current state of the national housing supply.

Surprisingly, as the chart shows, the national housing supply (measured in housing units) has never been higher in the past 65 years except for just before the housing/banking Great Recession Crash of 2008. However, we need to consider that this data is not adjusted for population increases. As such, the actual housing supply deficit is higher on a per capita basis.

Meanwhile, it’s important to note that California’s housing supply has failed to keep up with the robust growth enjoyed by the rest of the country. And there is zero evidence that this has anything to do with local government control or zoning. The facts suggest that this is primarily due to the state’s misguided housing policy and its blind pursuit of misguided, punitive, top-down methods.

Regardless of California’s unique policy failures, in all markets across the country, buyers are scarce and housing sales have collapsed. Both pending sales and sales of existing homes are hitting all-time lows.

Historically, this divergence between rising housing supply and decreasing housing demand is extremely rare. So what gives? Why does housing, particularly for middle-class and low-income people, remain so unaffordable?

As thoroughly explained in Paradigm Shift: Rethinking Housing Affordability, this “unaffordability” phenomenon is primarily driven by a trend that started in the early 1980s, leading to the general impoverishment of the American middle class.

At present the housing market is frozen. Owners are not selling and buyers are scarce except at the high end of the luxury housing market (which is why you will read articles saying that housing prices are still rising – the historically disproportionate number of high-end sales are skewing the weighted averages of the data).

Simply put, wages and wealth accumulation for the average American family have failed to keep up with the rising costs of living, not just for the cost of housing. The chart below shows that housing is not the worst inflation problem families face compared to the costs of energy, healthcare, college tuition, and other goods and services.

How we measure is as important as what we measure

As Governor Newsom noted in his book, CitizenVille, we are living in a 24/7, choice-driven, instant-access world but the government’s operating methods are state of the art, 1975. Many of those methods were developed as far back as the 1950s and have never been seriously questioned or updated. One unfortunate example of this is the methods the Federal Reserve uses to assess housing inflation. This is very important because the Fed’s interest rate decisions are based on those methods and have dramatic impacts on housing prices, financial markets, and borrowing costs.

Here are the methods that the Fed uses to assess housing inflation. Housing costs used in the Consumer Price Index (CPI) have two main components.

The first method is called the “Rent of Primary Residence.” (RPR) This attempts to measure the cost of renting a home or an apartment and accounts for around 7.6% of the total CPI weight. The Bureau of Labor Statistics (BLS) surveys rental units every 6 months to calculate this index and then publishes those results sometime after that. Generally, when it’s used by the Fed, it is already many months old. Worse still, the data source for the geographic distribution of housing units and percentages of renters to owners is based on the 2010 Census, which is now 14 years old.

The RPR data is derived from a fairly complex process that includes surveying actual rents in different places and market segments, estimating the costs of utilities and amenities, and then applying “weighted” averages to the data and calculating “relative” prices using various formulas based on historical norms, etc.

The second method is called “Owners' Equivalent Rent” (OER). This accounts for around 24% of the total CPI weight (3 times more than the rental survey) and is supposed to measure the cost of “housing services” for homeowners. But it’s not based on any actual data. Instead, it’s based on something they call “rental equivalence,” which is an estimate of how much a homeowner would have to pay to rent their own home. The BLS goes out and asks about 1,500 homeowners to estimate how much their home would rent for if they rented it instead of owning it.

It's hard to believe that anyone would consider this data reliable.

And if that wasn’t bad enough, the Fed admits that the OER housing data is also typically about 6 months old by the time the Fed receives it and that the OER “data” doesn’t reflect any real housing data such as home prices, mortgage rates, or other homeownership costs.

These two "methods," combined, produce so-called “data” that account for 1/3rd of the Consumer Price index that the Fed relies on to make its decisions about where to set interest rates.


The Fed Funds Rate has a dramatic impact on housing affordability because it directly impacts bank lending rates for home mortgages. As such, the difference between a 7%, 30-year fixed rate mortgage and the 3% mortgage rates we saw a few years ago has had a significant impact on the average homebuyer’s ability to qualify for a loan.

Inflation in the real world

According to the official Federal Reserve “data,” the annual, year-over-year inflation rate is currently at 3.3%. That is 65% higher than the Fed’s 2% annual inflation rate goal target. Thus, the Fed, in its infinite wisdom, is sticking to holding the Fed Funds Rate at 5.25 to 5.50% indefinitely.

But is inflation really at 3.3%?

It is the height of irony that in defending its position on interest rates, the Federal Reserve Board asserts, in sonorous tones, that their decisions on rates are “data dependent.”

A better way to measure inflation

In December 2021, a broad-based collaboration of finance and technology companies created a new inflation-measuring method called the Trueflation Index. It is based on actual, real-time data that accurately measures increases and decreases in the costs of goods and services in all sectors of the economy.

Unsurprisingly, its results are far superior to the methods being used by the Fed.

As of the date of this article (Trueflation is updated in real-time), the U.S. annual inflation rate is just 2.15%. That is 35% lower than the CPI calculation, or put another way, the CPI number the Fed is using is 53% higher than the Trueflation rate!

As a result of this disparity, using the example of a 30-year, fixed rate mortgage for a $750,000 home that requires the buyer to put down a 20% down payment, for every 1% increase in the mortgage interest rate, the home value would need to decrease by approximately 13.80% to maintain the same monthly payment for the buyer.

Put another way, a buyer’s ability to qualify is reduced from being able to get a loan to buy a $750,000 home to only being able to buy a $646,500 home if they only have a fixed amount of money for a down payment.

When the Fed’s assumptions about inflation are higher than needed, as they are now, it makes housing much less affordable. As such, the Fed is now the primary driver of "sticky" inflation and the housing industry collapse we’re witnessing.

This is really dumb and counterproductive.

Maybe the 'white shoe' crowd on the Federal Reserve Board should step into the 21st Century, buy some new computers and software and AI tech, and start finding better ways to measure inflation in real-time. But it’s probably a pipe dream to even hope that the government could ever possibly do anything that sensible. 

However, as things are, the Fed has to either start using real time data to gauge how to set the Federal Funds rate, very soon, or it has to think about carving out some kind of relief for the housing industry.

Perhaps the Fed, in conjunction with the Treasury and various quasi-governmental mortgage purchasing agencies (Fannie Mae, Freddie Mac, et al) and Congress, should try to find a way separate the Funds Rate for banks from mortgage rates (similar to how a combination of loan guarantees, special mortgage backed securities, and other legislative actions that created the G.I. Bill after WWII) in order to avoid a recession-inducing housing debacle.

This could be a short term fix with a sunset date, but something's gotta give.