Home Price Recovery and the Federal Reserve

March 15th, 2012 by 

We have dealt a lot recently with historically low interest rates and their implications on not only the cost of housing and mortgages, but also implications for consumer credit and inflation. Although we have explained home price affordability in the San Francisco Bay Area before, we haven’t discussed the large variance in regional real estate prices.

The Federal Reserve announced Wednesday (amongst other things...) that they plan to keep the federal funds target rate extremely low, at or near 0.00% through early 2014. All of this is happening during a time when President Obama’s approval rate is at 50% and we have seen the greatest six-month employment increase since 2006.

So why the pessimism around the recovery?  Why the need to reiterate the Fed’s ability to pursue further Quantitative Easing?  Is Operation Twist working?

One of the major undercurrents of Federal Reserve and fiscal policy surrounds the performance of the U.S. housing market. I currently have no prediction about where the housing market is going to go tomorrow (or how it will under- or over-perform in the next five to ten years), but I can say that the past three years of “recovery” can be described as “less-than-stellar”.

Below, I have plotted out the S&P Case-Shiller Index (seasonally-adjusted) tracking the performance of housing prices in ten major metropolitan areas: Phoenix, Los Angeles, Las Vegas, Detroit, Chicago, Charlotte, Boston, Dallas, Minneapolis and Miami since 2000. They are specifically chosen to show an array of varying results over the past twelve years. Areas such as the southwestern United States and Florida saw a much larger regional bubble than the rest of the country and the ensuing crash has affected those areas most. Detroit performed poorly throughout most of the new millennium due to a struggling labor market. Dallas, Charlotte and Minneapolis are meant to be a sort of control group: areas that did not see a significant run-up or decrease.

One of the key points to note is that since mid-2008, when a lot (but not all) of the decrease had already taken place, performance has been relatively poor in most of the major markets. In areas like Dallas where a huge run-up (or a huge decrease) was not seen, there still hasn’t been a significant recovery. In other areas, such as Phoenix, Las Vegas and Miami, the decrease appears to be continuing.

The elephant in the room is that all of this is occurring while mortgage rates are at historical lows. Other costs of housing, such as house insurance, real estate taxes (based on falling prices), and HOA fees continue to remain extremely low. This means that these low housing prices are continuing while the actual cost of a mortgage (measured by APY) is unfathomably low. Government programs such as HARP and HAMP, ostensibly to help out homeowners who are threatened by foreclosure, may only be maintaining an ill-performing housing market.  Additionally, the actual TARP bailout of many retail banks and the GSEs Fannie Mae and Freddie Mac may be doing the same.

With a recovering labor market and low interest rates, is the low housing price phenomena due to housing inventory? Does the housing market accurately reflect labor market predictions? In what order will the following come: an increase in mortgage rates, an increase in home prices, an increase in federal funds rate/quantitative tightening?


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