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| Credit: iStock |
The general perception that a household making the median income should be able to afford to buy the median-priced house has some rough logic to it, although the actual math is more complicated than it seems on the surface. The “price” of the median priced home is only part of the issue because the ability of a particular household to afford that home is also affected by interest rates (which have remained stubbornly high), by insurance costs (which have been rapidly rising), and by local property taxes (which have also been trending upward). A typical mortgage payment includes all three of those costs and yet most articles focus solely on home price as the issue.
That is our first clue to the nature of the housing affordability dilemma. If all you have is a simplistic understanding of a really complex problem, it is going to be really hard to come up with a good solution. It is common for people analyzing the problem and proposing a solution to focus on one aspect of the housing market when in fact the issue of housing affordability has many dimensions. The problem has lots of moving parts and it is easy to get distracted by one small element of the housing market or some short term trend that tends to suggest a pain-free solution.
A recent CMBC article was titled “Nearly one-third of major U.S. housing markets now see falling home prices.” [2] Pop the champagne! The problem will solve itself as falling prices restore affordability for the average American. Of course, that same title implies that prices are not falling in two-thirds of major U.S. markets, so maybe put the champagne back on ice. Yes, home prices have moderated over the past year or two in some locations, but the forces that are causing that to happen will not come close to solving the problem. For reasons I will discuss later, the “falling prices” trend is likely to be short-lived because there are powerful forces that don’t really want prices to fall and they will push back until the trend peters out.
That brings us to clue number two in our quest to solve the housing affordability dilemma. There are a lot of actors who influence the housing market and they are not all pushing in the same direction. Everyone says they want to solve the housing affordability problem but every actor has their own agenda and their own set of blinders that prevent seeing the big picture. It even makes it hard to discuss the problem because what I mean by housing affordability is likely to be subtly different from what you mean. Thus, housing discussions often go in circles because we use the same words but with slightly different meanings.
But here is the real kicker – every actor sincerely believes they are doing the right thing. There is no deep, dark conspiracy and no greedy genius intent on destroying the American dream of homeownership. The recurring theme of this article (and a companion article that I will post next month) is that the problem of housing affordability has been caused by organizations and institutions with good intentions trying to do the right thing. There is an old proverb that says “the road to hell is paved with good intentions” and our current housing problem is a good example. We think we are helping dig ourselves out of the hole we are in, but in reality we are making the hole deeper and deeper.
Just How Bad Is It?
Pretty bad, but perhaps not quite as bad as many people in the press would have you believe. Housing tends to be a relatively cyclical market with periodic booms and busts. The accompanying chart shows that volatility in terms of total housing starts over the past seven decades. We appear to be coming out of a bubble with housing starts returning to the historic trend line. Typically, housing prices fall slightly, or at least plateau, during the post-bubble phase – unless it was a really big bubble and then prices fall dramatically (e.g. the 2008 Great Recession). Unfortunately, I don’t expect housing prices to fall enough to really solve the affordability problem.
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| Source: St. Louis Federal Reserve Bank |
The worst part of the current situation is that income and housing prices have diverged dramatically over the past 10 to 15 years. The second chart illustrates that separation (all values are indexed to 2011 = 100 to simplify comparisons). I am intentionally focusing on median household income and median housing price because I think that is the essential dilemma that we face. No one thinks that rich people will have difficulty affording a nice home and very few people expect the private market to solve the problem of housing the very poor. But there is a widespread expectation that the middle class should be able to buy a reasonably nice place to live. That expectation may or may not be realistic, but in the age of social media perception is reality. If I work hard and make a decent salary but feel priced out of the housing market, I am going to be unhappy. As the chart shows, real income has grown by roughly 25 percent while the median home price has nearly doubled. Our society and our cities need to deal with that reality.
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| Source: St. Louis Federal Reserve Bank |
The second chart also includes the U.S. Consumer Price Index for housing which is a much broader indicator of what people spend for housing than housing price alone. That measure tracks much more closely with income until the pandemic hits and then it rises significantly faster than income as well. There is also the perception that housing affordability is primarily a coastal problem. It is certainly true that housing affordability is especially bad in Los Angeles, San Francisco, New York, Boston and other big, coastal cities, but it is also a problem in midwestern cities. In fact, the chart shows that the midwest is slightly worse off than the national average. There is a lot of variation that is hidden by the averages, but this is a problem that affects just about every city of significant size.
One final measure of housing affordability is the ratio of home prices to income. According to the Joint Center for Housing Studies at Harvard University, that ratio is at historic highs. [3] For the 100 largest metro areas, only in the run-up to the Great Recession did the ratio equal current levels. For the past several years, the average home price has been roughly 5 times higher than the average household income. What is just as striking is the degree to which high ratios have become widespread across the top 100 markets. Even at the previous peak in 2005 - 2006, only 40 to 50 percent of metro areas had a ratio of 4 or above. In 2024, that share has ballooned to 75 percent. Similarly, in ‘05/’06 a quarter of the metro areas had a ratio of 3 or below, but that share is now down to less than 5 percent.
The Wall Street View of Affordability
We often think of housing as a very local, very personal thing. Our friendly realtor helps us find the perfect home, our friendly loan officer helps us navigate the purchase process, and our friends and family help us move in. The reality, however, is that housing is big business, one which is complicated, heavily regulated and impersonal. The housing industry as a whole accounts for 16 to 18 percent of the nation’s gross domestic product in a typical year, and any industry that big is going to attract a lot of attention from Wall Street bankers and financiers.
In many ways, the financial side of the industry is the tail that wags the housing dog, but it is a world which most people don’t understand and its impact on housing affordability is often underappreciated. To get an understanding of where we are, it is helpful to look back at where we started and to track the key changes along the way.
For much of the 1800s, a personal loan to buy a house was relatively rare. The required down payment was often more than 50 percent, the term was relatively short (5 to 8 years), and payments were mostly interest followed by a balloon payment at the end for the remaining balance. Consequently, most loans were made to wealthy individuals, most housing was built incrementally (not in big subdivisions), and most people were renters not owners.
In the last decades of the 1800s, a new form of financing known as a building and loan association became popular. This was typically a small, local, self-help approach to home ownership. Associations were formed by a group of local investors who paid an initial fee and subscribed to purchase a certain number of shares (typically less than 10, each with a value of just a few hundred dollars). They made monthly payments toward the purchase of those shares at a rate which often took 15 years or more to pay off. Members could apply for loans to purchase or build a home using their shares as collateral. Profits from interest on the loans were returned to the members as a dividend. Fully paying off the shares would effectively cancel the loan.
This approach significantly improved access to home financing for the average worker and became so popular that there were more than 12,000 building and loan associations by 1927. Unfortunately, the Great Depression hit the associations hard and many of them folded which meant that the members lost the value they had accumulated by buying shares. The role of the building and loan associations was gradually taken over by a new, federally chartered institution known as a Savings & Loan Association (S&L). In exchange for complying with federal regulations, S&Ls could borrow money from the Federal Home Loan Bank Board and their deposits were guaranteed by the Federal Savings and Loan Insurance Corporation.
At the same time, the Home Owners’ Loan Corporation was formed to buy delinquent mortgages and refinance them with longer terms and lower interest rates. These actions (and others) stabilized the mortgage market and lessened the rate of foreclosures, but ushered in an era of federal involvement in the housing finance arena. The rise of S&Ls (and rule changes that made it easier for commercial banks to issue mortgages) meant that loans were no longer managed by groups of neighborhoods banding together for mutual aid, but rather by the owners and investors of financial institutions.
In 1938, the Federal National Mortgage Association (commonly known as Fannie Mae) was formed with the express purpose of greatly expanding the secondary mortgage market and providing federal money to local banks to finance home loans. Fannie Mae operated by buying mortgages from local financial institutions, bundling them together into mortgage backed securities (MBS), and then selling those securities to investors around the world. The net effect was to expand the pool of money available for mortgage loans and to relieve local banks from having to carry long-term mortgages on their books.
Banks could hold onto loans if they wished, but would generally sell the loans to Fannie Mae and use the proceeds to issue more mortgages. Banks made money by charging fees for their role in the loan origination process and by earning a portion of the interest rate spread between what they charged borrowers and what they received when selling the loan. Fannie Mae makes money from the spread between what they buy the loans for and what they sell the mortgage backed securities for. They also charge fees for guaranteeing the prompt payment of principal and interest on the mortgages that underlie the securities.
The securitization of mortgages has become an enormous market and Fannie Mae is one of the world’s largest corporations based on asset value. The mix of government organizations and financial institutions that comprise the secondary mortgage market have undergone a variety of changes since 1938, some good and some bad. But the bottom line is this: Fannie Mae has provided liquidity to the mortgage market through both good economic times and bad, which has been a huge benefit to the housing industry. It has also removed much of the risk from local mortgage originators and has standardized the mortgage application and approval process. On top of all of that, it has probably lowered interest rates to at least some degree. All of these are good things.
There is, however, a dark side to all of this. While the ultimate investor makes money from the interest on the mortgage, all of the other players – the banks, the S&Ls, Fannie Mae (and the various spin-offs), and the Wall Street financiers involved in the MBS process – make their money from fees and from the spread on each transaction. They value volume more than anything else. So when they say “we want to make homebuying more affordable” what they really mean is “we want more people to qualify for a mortgage so that our volume remains high.”
That is the motivation behind “innovations” such as the adjustable rate mortgage, low down payment requirements, private mortgage insurance, or reduced qualification requirements for veterans or low-income households. All of these actions have been touted as making housing more affordable, but that is not what most people mean when they think of affordability. None of these things lower the actual price of the home being purchased to any great degree – if anything, they make prices go up by stimulating demand.
In fact, one could argue that Wall Street financiers and the leaders of Fannie Mae (et al) don’t really want housing prices to fall. A significant period of declining home prices would be great news for middle class households who feel priced out of the market, but it would have two side effects that the MBS industry would hate:
Mortgage delinquency rates and foreclosures would rise, particularly among mortgage holders with low down payments, and rising delinquencies make selling mortgage backed securities more difficult. This isn’t likely to be serious enough to trigger a financial crisis, but it could easily put a crimp in profits.
Falling home prices almost always lead to falling housing starts which would reduce the volume of MBS business – another hit to profits.
Hypocritical But Not Alone
It is easy to call out bankers and the securities industry as being hypocritical. Expanding access to the mortgage process does benefit their business (and their annual bonuses) but it also benefits people who are on the margins of qualifying for homeownership. So their behavior isn’t terrible, it just isn’t very helpful at solving the real problem of home prices being out of whack with income levels.
Mortgage bankers might be somewhat hypocritical but they certainly aren’t alone. Charles Marohn, the founder of the Strong Towns movement, put together this list of who benefits from rising home prices and who doesn’t: [4]
Benefits Doesn’t Benefit
Local government Renters
State government The poor
Federal government
Existing homeowners
Banks & insurance companies
Developers & contractors
Land speculators
Realtors
Pension funds
To be clear, I am on the “benefits” side of the list as an existing homeowner so by all rights I should be working against housing affordability. The point that I think Marohn is making is that there are a lot of people and organizations who might say they want housing to be more affordable but which might be engaging in the type of double-talk that the mortgage securities industry has been accused of. No wonder the problem has been so difficult to solve.
The reality is that if we really want to solve the mismatch between housing price and income then a lot of people are going to feel some pain. Not catastrophic pain, but enough to be uncomfortable. My house, which has appreciated in value nicely over the past decade or two, might actually fall in value. The property tax revenue stream which for many cities has been on an upward trajectory due to rising home prices might flatten for several years. Developers who bought land on the urban fringe thinking that they could build expensive houses and sell them at a lucrative price might have to put their plans on hold. I think the long term result of falling home prices would be beneficial for our society but I’m not sure that we are public-spirited enough to actually follow through.
The Bottom Line
Over the past 15 years, there has been a widening gap between household income (which has risen slowly) and the price of housing (which has risen rapidly). Most of the stories in the press focus on the cost of buying a home even though the cost issues affect rental housing as well. I have argued against the notion that owning your home is an essential part of the American dream (see Post 51), but the belief seems to be as strong as ever. Still, there is an undeniable logic to the idea that a middle class household with stable employment and a decent paycheck should be able to afford a median priced home. The fact that they can’t in most metro areas is the source of considerable dissatisfaction and angst.
What is particularly frustrating is that most of the trend lines are moving in the wrong direction despite all the talk about solving the affordability dilemma. Doing more of what we have been doing appears to be simply making the hole we are in deeper.
You would think that politicians at all levels of government would be scrambling like crazy to solve this problem and, in fact, most of them claim to be working diligently on the problem. Donald Trump even proposed opening up federal land for the building of up to 10 “Freedom Cities” the size of Washington, D.C. to increase housing supply and bring prices down. No progress seems to have been made on implementing this idea, perhaps because there is little evidence that a lack of land at the national level is the key issue that needs to be addressed.
Predictably, the proposals which have gained traction – expanding credit score options, reducing the impact of student loan debt, or allowing cryptocurrency to be considered a household asset – are all oriented toward expanding the pool of potential mortgage applicants rather than lowering the actual cost of housing. In short, don’t count on the Federal government (or Wall Street) to solve this problem. Instead, I believe we need to combine some out-of-the-box thinking with some hard choices on priorities to really shift the way we produce housing. Do I have all the answers? No, but I have some ideas that might move us in the right direction. Check back next month for the second part of this discussion.
Notes:
1. Elizabeth Yost; “Kansas City homebuyers now need six figures to afford a house”; August 2025; Kansas City Business Journal; https://www.bizjournals.com/kansascity/news/2025/08/15/kc-buyers-income-to-afford-a-home-2025.html
2. Diana Olick; “Nearly one-third of major U.S. housing markets now see falling home prices”; July 2025; CNBC; https://www.bizjournals.com/kansascity/news/2025/08/15/kc-buyers-income-to-afford-a-home-2025.html
3. “The State of the Nation’s Housing 2025”; Joint Center for Housing Studies, Harvard University; https://www.jchs.harvard.edu/sites/default/files/reports/files/Harvard_JCHS_The_State_of_the_Nations_Housing_2025.pdf
4. Charles Marohn; “Who Benefits From Lower Housing Prices?" April 2019; Strong Towns; https://www.strongtowns.org/journal/2019/4/9/who-benefits-from-lower-housing-prices
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