The Fed's housing market objectives
Posted by Pat Kitano at 10/14/2007 10:19 PM 
Categories: Global Real Estate, Real Estate Economics, Economy
Categories: Global Real Estate, Real Estate Economics, Economy
Daily, I read a lot of market and economics blogs and Bloomberg-type websites; after all I was on Wall Street for eight years. I'm going to assume that real estate professionals who are trying to keep up with the dizzy markets since "subprime summer" may find it difficult to come to any conclusion about the housing market except "wait for it to settle". That's because every day the media and the blog commentary seem to focus on only one or two aspects of the economy, whether it's inflation targets, dollar dumping, subprime mess, housing starts, or various crash scenarios. No author has really described how the Fed plans to deal with the housing market in context with all these moving parts, and done it simply without a lot of technical talk or arcane interpretations of monetary policy.
Here's a simple explanation about the Fed's target "good case" scenario, starting with the housing market:
Housing market - Keep housing prices on a flat line - the Fed's objective is to insure that dropping housing prices won't dampen consumer confidence and trigger the dreaded recession. The Fed, and US home owners, won't mind if the housing price future looks like this:
How is the Fed trying to keep housing prices propped up?
First, by dropping interest rates so the economy continues to chug along and Americans can continue to buy homes, but this causes:
Falling dollar - admittedly, the falling US dollar and its relationship with potential inflation is way too complicated an economic issue for a simple interpretation. If the falling dollar doesn't plunge the US into a recession as some economic doomers purport, then it may support US housing prices...
1) Sports analogy - every week, college football's #1 (and sadly #2) teams are being upset supposedly due to sports recruitment parity. The global economy is also moving to wealth parity... in most simplistic terms, global wealth is being redistributed from the US to China and India. That means even if most Americans can't afford those $1 million mortgages, a lot of rich foreigners can (yes, they are buying in Manhattan, San Francisco and Florida now).
2) The dollar is weakening, real estate has become an accepted global investment product, and the overseas investors are coming.
3) I should mention that the world is united in ensuring that the dollar does keep its value... European exporters are hurt by a weak dollar. Remember that currency values are relative - the dollar won't nosedive if the world is propping it up. (updated 10/15 8:10am pdt)
And to keep housing prices floating at current levels, credit needs to be available...
Credit crunch - The Fed and the banks look like they are ready to prop up the credit markets with a $100 billion fund. Although consumers decry "bank bailout!", any Fed moves to create lender liquidity will stimulate real estate transactions.
Housing starts - the Fed secretly wouldn't care if housing starts drop to zero. The inventory overhang needs correction, and the builders as a sector don't have any clout with the Fed, not like the lenders do.
Subprime - in the callous, grander economic scheme, the subprime victims themselves don't affect the overall economy because they were already "poor". The victims are a political issue. Subprime problems only affects certain regions, and subprime affected properties can be viewed as an extension of the inventory overhang.
Bubble - Housing bubble enthusiasts believe housing prices should fall back to levels where it would be if there wasn't such dramatic appreciation between 1998-2006. The Fed wants the public to believe that the global economy has changed dramatically enough that current housing prices accurately reflect the market, and the market is close to a bottom. Again, two conflicting arguments that both make sense.
Technorati Tags: Fed, housing market, subprime, credit crunch, housing starts, inflation
With unprecedented growth, comes unprecedented correction.
Great insight (as usual) Pat. The inconvenient truth for many is that the Fed must balance the economy under new rules, global rules...of which housing is a pillar of, not the entire foundation. The housing market got very 'liquid' in recent years, compared to the past...hence the growth and new volatility.
If the Fed can find a way to maintain sensible appreciation in relation to inflation, they have effectively done their job.
You're sports analogy is fitting...it's a game, most people just don't know the rules or refuse to acknowledge them.
Americans in general believe that we ought to be completely self contained, alas that's just not an option.
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Pat, I am a regular reader of your blog; however, I rarely provide comments. As always, you have provided very clever arguments in support of your analysis of the trends.
We know that the U.S. is not alone in sharing the most recent substantial real estate market growth (in fact, the recent boom is not just limited to the real estate market, it is a global asset boom). It is, in most part, the end result of a combination of various political and economic changes that the world had not seen before, including globalization, weakening dollar, introduction of euro, accelerated growth of other economies of the world, inflationary pressures, etc..
The May 5, 2005, issue of The Economist discussed concerns of stagflation (slowing economy and growing prices) even then (which we are just beginning to feel). If stagflation continues to grow in the U.S., the U.S.’s already heavily-indebted consumers will have to cut back on their spending, which, in turn, will force the rest of the world to start spending more to keep the world economy growing. There is no chance of that happening. The Fed will be too worried about stagnation to let that happen and the central banks of other countries will be too concerned about inflation in their economies to cut rates.
So, we will continue to see cheap money in the months or maybe even years ahead. This will help balance the housing market.
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Pat - excellent post. (nominated for the odysseus medal)
Question:
Is it possible that a lot of the subprimers (like a big %) were actually spending a lot of money (credit cards, equity lines, etc..) over the past several years, playing a very important roll in the grander economic scheme?
Also, #1 & #2 comments were excellent.
Question for commenter #2:
"So, we will continue to see cheap money in the months or maybe even years ahead."
How do you see it ending in the coming months or years? Good or bad?
I do not want to be one of those economic doomers, but I have to tell you...I am a consumer and my gut does not feel the same way it did 5 years ago.
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Dave, thanks very much! I started a reply last night and once I realized how long it was, I decided the concepts we're bringing up warranted a new article.
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Dave,
It is difficult to tell how it is going to end in the long run. But we know one thing that people and establishments that have truckloads of debt (temporarily) benefit from cheap money (which I also call “real” inflation). When I think of heavily-indebted establishments one pops up in my head immediately: the U.S. government.
Although many will argue against this point, I believe that at this point in history the U.S. government (the heavily-indebted establishment that also controls the dollar) stands to benefit from cheap dollar.
With respect to housing, I am optimistic. The increased supply of money coupled with rising rents (at least here in Los Angeles) should help stabilize the housing market.
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