Aaron Layman has never seen a more competitive housing market.

Layman, a real estate broker and housing analyst based in Denton County, Texas, said homes for sale in the Dallas-Fort Worth area are selling in about six days on average, compared to the typical 45-day average. A rush of speculators has flooded the market with all-cash offers and whittled inventory down to about 15% of typical levels. And modest, single-family homes are going for 20% more than their listing price in a matter of hours.

"It's just crazy. Houses will get listed on Thursday and they'll be looking at 20 offers by Sunday evening," Layman said in an interview.

Those same conditions are playing out in housing markets across the U.S. as historically low mortgage rates, shifting work conditions and more than a year of pent-up savings have created an extreme imbalance between supply and demand. U.S. home values hit an all-time high in April and posted the biggest annual jump — 11.6% — since 2005, according to Zillow, an online real estate marketplace.

Home values in April spiked in the hottest real estate markets, jumping 25.5% year over year in Austin, Texas, 20.4% in Phoenix and 18.3% in Salt Lake City, according to Zillow.

Supply has also collapsed. In April, there were 1.16 million homes for sale in the U.S., down 20.5% from April 2020, the National Association of Realtors reported May 21.

This unprecedented sellers' market, Layman believes, is also being intensified by the Federal Reserve's monetary policy, specifically the central bank's continued monthly purchases of $40 billion in mortgage-backed securities.

The market ran white-hot in April, roughly a year after the Fed began buying $40 billion in mortgage-backed securities in an effort to stave off the worst economic impacts of the COVID-19 pandemic. The Fed's strategy was similar to a program the central bank launched in January 2009 to buy hundreds of billions of dollars worth of MBS in response to the then-current financial crisis.

The central bank is now facing criticism that its monetary policy is further contributing to a potential crisis in the domestic housing sector.

Fueling strength

On March 23, 2020, as the coronavirus pandemic was taking root, the Fed announced that it would continue its quantitative easing program indefinitely. The plan included monthly purchases of $80 billion in U.S. Treasury bonds and $40 billion in MBS, which are bonds typically secured by a pool of similar home loans.

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Market participants have been on edge over when the Fed may begin to ease, or taper, these purchases, but the MBS buys have come under increased scrutiny as the domestic real estate market has caught fire.

"It's fueling the real strength we're seeing in the housing market, there's no question," said Mickey Levy, chief economist for the Americas and Asia at Berenberg Capital Markets LLC. "It's keeping mortgage rates lower than they would be otherwise … there's just no argument for the Fed to continue buying MBS."

The Fed held more than $1.1 trillion in MBS by May 2010 following more than a year of buying the bonds in response to the financial crisis. Since it ramped up its purchases in March 2020, the central bank has added roughly $900 billion in MBS and owned about 32% of the total market for the securities as of May, according to Bianco Research.

Now, with approximately $2.2 trillion of MBS in U.S. federal holdings, economists and strategists are asking whether the Fed is doing more harm than good for a real estate sector in a buying frenzy.

"The Federal Reserve's asset purchases artificially lower interest rates and financing costs, which reinforces the buyer's need to pay higher prices. It is even further detrimental because the higher price means that the buyer is borrowing more and taking on additional leverage," said Michael O'Rourke, chief market strategist at JonesTrading, in an interview.

Some central bank officials have indicated a need to at least curb MBS purchases as low refinancing costs and low mortgage rates have spurred a recovery in real estate buying that demand is unable to keep up with at the moment.

Eric Rosengren, president and CEO of the Boston Fed, said May 5 that the mortgage market "probably doesn't need as much support now."

"In fact, one of my financial stability concerns would be if the housing market gets too overheated," Rosengren said during a virtual event organized by Boston College.

Taper trouble

Fed Chairman Jerome Powell has given no indication of when the Fed may begin even discussing tapering its $120 billion in monthly securities purchases; however, the minutes of the Federal Open Market Committee's April meeting indicated that such a discussion may be coming.

"A number of participants suggested that if the economy continued to make rapid progress toward the Committee's goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases," according to the minutes, which were released May 19.

The Fed is extremely hesitant to even indicate an easing of its securities buys due to the potential to repeat the 2013 "taper tantrum," when bond yields spiked. A repeat could unnerve investors and cause a jump in volatility in bond and equity markets.

"A premature jump in yields would tighten monetary conditions and could derail the recovery," said Win Thin, global head of currency strategy with Brown Brothers Harriman & Co. "That is why the Fed is being so cautious."

There is also a question of just how much impact MBS purchases are having on the ongoing house-buying boom, said Nancy Vanden Houten, lead economist with Oxford Economics. The Fed's purchases have only had a "small role" in the housing market's current conditions, Vanden Houten said, adding, "I think the housing market's issues run much deeper than the Fed's [quantitative easing] program."

A shortage of housing inventory has existed for years, and much of the current buying spree has more to do with people working from home and searching for more space than with Fed policy, Vanden Houten said. The Fed will likely be able to design the reduction in bond purchases without much market impact.

"I don't think the Fed is going to end the program early and I don't expect a taper tantrum when it does," Vanden Houten said.

'Operation Switch'

To avoid the possibility of such a tantrum, economists have proposed a "switch" rather than a "taper," said Berenberg's Levy. Instead of continuing to buy MBS, the Fed would switch that $40 billion to buy longer-dated U.S. Treasury bonds instead, such as benchmark 10-year and 30-year bonds.

"A 'switch' is not a 'taper,' rather it shows the Fed willing to address market dysfunction and establishes a longer runway to its end goals," Satish Mansukhani, an MBS strategist with Bank of America Securities, wrote in a March 12 paper that dubbed the idea "Operation Switch."

Layman, the Texas real estate broker, sees few options without market consequences and noted that ending, easing or continuing MBS buys all may ultimately worsen the imbalance in the housing market by causing a spike in rates.

"I think they know in their heart of hearts that they've created a giant mess and there is no easy fix," Layman said. "They're going to keep doing what they're doing and hope it comes to a soft landing. But it's going to be very tricky to do."