After getting over the trauma of learning Pluto was not a planet [Detroit FP] yesterday, I turned my attention back to the housing market.

Will the Fed raise rates, or won’t they? Its been an exhausting year trying to second guess them. It appears, as past experience dictates, they went a little too far and now housing is weakening more rapidly than expected. Now the Fed has to figure out how to get the nation’s economy out of its dependency on housing. They are discussing this and other issues now at their annual retreat in Jackson Hole. [Bloomberg]

Bernanke, Fed chairman since February, takes the Jackson Hole, Wyoming, podium today after two days of reports showing home sales and prices retreating after a five-year boom spurred by the strategy he advocated.

The results of that policy are now complicating his task as he attempts to maintain growth while wrestling down prices. Given real estate’s importance to the economy, the Fed may have to hold interest rates steady even as inflation exceeds Bernanke’s comfort zone of 1 percent to 2 percent, excluding food and energy.

There have been some interesting Fed studies over the past year, with mixed messages and some contradictions. Here are two examples:

Falling Rates Fueled Housing Boom: A Trend and Variance Decomposition of the Rent-Price Ratio in Housing Markets [pdf]

Housing Prices May Become More Volatile, Fed Report Says [WSJ]

The rise in housing prices over the past decade “owes significantly” to falling inflation-adjusted interest rates and changes in the mix between rates and the “housing premium,” which could mean more volatile home prices in coming years, according to a paper written by Federal Reserve economists.

Economic Fundamentals Fueled Housing Boom: The great turn-of-the-century housing boom [pdf]

The Chicago Fed says that low mortgage rates did not fuel the real estate housing boom. Spike in housing is no bubble, Fed says [Philly.com]

“While we have so far mostly avoided discussing housing prices, our findings do suggest that to the extent that house prices have grown considerably in recent years, this is not due to unusually excessive speculation in the housing market, such as would occur in a bubble. Instead, our findings point toward the high prices being driven by fundamentals.”

[Of course low mortgage rates fueled the housing boom -ed]


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11 Responses to “Low Rates Did/Did Not Fuel The Housing Boom”

  1. Rich In NNJ says:

    I feel, at this point any move by the Fed will have no effect on housing. As you mentioned, “Market psychology/mob mentality is a fragile thing.” I think everyone is a little “touched” and now has Housing Anxiety. The Fed should stick to it’s no one role (or is it mandate) and deal with inflation. The sooner we take the medicine, the sooner we’ll get better.

    And I agree that low mortgage rates fueled the housing boom. And then that old market psychology/mob mentality took over!

  2. Rich In NNJ says:

    Sorry, that should read: The Fed should stick to it’s NUMBER one role…

  3. nworb says:

    I agree with Rich that the current market is due to mob mentality, but I don’t agree with the Fed having nothing to do with this. If the Fed starts saying that the market is going to fall, since they are a major player in the national financial industry, they will increase the chances that the general public will believe that. I’m not saying that the fed has a straight cause/effect relationship with the market, just that they are still a major factor in public opinion.

    If they public opinion thinks that the market is tanking, then the market will tank where the fundamentals (rent levels, cost of dwelling) are not inline with the buying prices. In New York, the fundamentals are inline for owner occupied where the owner makes a higher tax bracket – I don’t think they are inline for investment properties at all.

  4. John K says:

    What fundamentals have changed, then, if we are to believe the Chicago Fed? (I think they’re right, btw.)

    (I haven’t read the study, yet. Maybe they talk about it. I’m on dial-up, what can I say?)

  5. After reading the 2nd PDF I cant help but wonder if there is a strong correlation between the rate of homeownership and the decline in the savings rate.

    My second thought is of course buyers are payment sensitive and lower interest rates would help keep prices up.

  6. Gee the more I read about the real estate market, interest rates and the economy the less I know. Everyone has an opinion. I maintain that as long as there is population growth either by birth or imigration housing demand will remain strong, and so will appreciation. In addition as long as baby boomers have a dime to spend, they will spend it instead of saving it which will keep the economy chugging along. Local real estate markets are strongly affected by local economic conditions.

  7. John K says:

    In the first Fed study, they talk about “housing premium”.

    I have no idea what that means!!! What is a housing premium? The idea that a house is worth more than an apartment, because it’s better quality, and therefore is worth paying a premium?

    I give up. Anyone?

  8. UrbanDigs says:

    I think ‘housing premium’ refers to the price that the seller gets from a company who values the fundamentals of the house and the revenue it will generate in the years to come. The premium price given to the seller is generally above the current market value of the home, giving the homeowner a boost in valuation and the takeover party a drag in valuation.

    Oh wait, sorry that’s the stock market.

  9. UrbanDigs says:

    Sorr Jonathan, couldnt help it! Agreed with Rich in NNJ that future moves the fed makes will have little effect on housing. We still have 3 rate hikes (75 Bps) to funnel through the economic system and show its effects.

    Furthermore, as Rich notes, the primary function of the fed is to control price stability and inflation. According to the fed.gov site, the primary purpose is: It is responsible for formulation of a monetary policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

    The first three of these responsibilities are directly affected by inflation, which is why I agree with Rich that the fed should inject a bit more medicine, but that wont happen for at least another 1-2 meetings; if at all.

    I just hope that inflation is NOT as bad as it looks and that above $70 oil, which has been there for months now and is lagging in its effects as well, doesn’t show its ugly face as everyone expects it to in future data that the fed will analyze.

    The fed really is in a tough spot, and yes I agree that their massive easing campaign after the dot com bust provided the catalyst for the greatest housing boom in recent history, ripe with speculative demand that is now scared sellers. With all that demand gone and buyers so cautious and wary of the short term future of housing, it will be hard for housing not to correct and the fed will have to decide if monetary policy needs to be adjusted because housing is headed south. Is that really the fed’s job? To keep housing afloat? No, it isn’t. And I think the fed is counting on a housing correction to slow the economy enough to combat inflation, rather than force them to raise rates more.

  10. Jonathan J. Miller says:

    Hi Noah! I do realize that the fed is not tweaking the funds rate because of housing – but I think we all want to believe they are. They are tweaking the economy and view housing as an important vehicle to steer the economy away from inflation. I don’t know if thats possible since the combination of high housing costs and rising fuel prices may eventually catch up with us.

    I think the housing market effects have not been fully impacted by the last few rate increases. If things are decelerating this fast, just imagine how much faster the potential decreases are in store for us when these last few increases flow through the economy, let alone a hurricane. Even if the economic data is good this week, such as gdp, I really don’t think we have any increases in store for us in the near term, and believe the odds are rising for rate decreases in 2007. But its a tightrope. Inflation feels like its knocking on the door so I agree that the fed is in a tough spot but I think they will likely be swayed if housing implodes in a few major markets.

  11. UrbanDigs says:

    Hard to argue that Jonathan. You make very valid points and every debate on the topic I see on CNBC mentions this ‘hard spot’ the fed is in.

    I’m curious to see what happens and will look at it as a learning experience for future similar times.

    Away for a while and leaving Friday so be well and I’ll try to catch up when I get back!