Home Price Recovery and the Federal Reserve

Posted By CameronDaniels Last updated March 15th, 2012 11 Comments

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?

Cheers,

Cameron Daniels

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http://moneymamba.com/ JT

I suspect we’ll see an increase in home prices, then Fed tightening, then an increase in mortgage rates.

The concern during the credit crisis was that trillions of dollars in wealth disappeared overnight. Since real estate seems to be the most available proxy for leverage to individuals, any decline in real estate values is deadly. Given that most people do not own all of their home, but own some of their home equity, a drop in home prices brings a disproportionately larger drop in credit. After 4Q 2011, the number of mortgage resets declined substantially. Now the only concern is shadow inventory – when is the US government going to dump its foreclosures on the market?

I don’t think you can have an employment recovery until housing turns around. Most homes are selling at a price well below the replacement value, so there really isn’t much economic incentive to build out. And I can’t see home prices rising until investment interest picks up. Hedge funds are snapping up homes, but no one wants to start a buying spree if there is not chance at a liquidity event. Until the US Government sells off its inventory, I can’t see investors bidding up prices.

Just my 2 cents, but what the heck do I know? It’s like throwing darts when you look at the macro.
- http://moneymamba.com/ JT
  
  I’ve been thinking about the structure of the real estate market, as well. Even if rates are low, and home prices are cheap, no newly employed person will get a shot at a mortgage until they have 2 years of income.
- http://myuniversitymoney.com/ My University Money
  
  This is a great insight JT. I always question people on why it is ok to leverage yourself 20-to-1 on your house, but everyone goes crazy when you talk about .5-to-1 leverage in other asset classes. But I never thought about the fact that all that real estate leverage made a housing crash much more detrimental in many ways than a stock market crash…
  - http://www.dqydj.net/ PK
    
    With FHA here you can even juice the leverage more – 28.57 to 1 with a 3.5% down payment (and assuming you have no other assets or debts, heh).
  - http://moneymamba.com/ JT
    
    Almost every recent financial crisis came from a housing crash. In 2008, a big drop in home values sent the world to crisis. A minor housing fallout in the early 1990s led to a recession. The Japanese “lost decade(s)” followed a housing correction, and asset valuation implosion. Ireland’s busted early, and now they’re practically bankrupt. Same thing with Spain, which saw housing prices peak in 2009.
    
    Rinse and repeat – time and time again we’ll do the same things over and over again and expect different results. It’s ridiculous. Mortgages are probably the most dangerous financial product, yet seemingly safer than others. It makes no sense to me whatsoever.
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http://www.thegeezergadgetguy.com/ Thad Puckett

All the costs of mortgages are historically low, yet I have friends who think it won’t help them to refinance.
http://www.101centavos.com/ Andrew @ 101centavos

Here’s an observation that means nothing on a macro level. I had lunch yesterday at a BBQ joint I hadn’t been to in a while. It’s a bit out of the way, out in what used to be the sticks on the edge of a bedroom community. On the way back, I noticed a brand new neighborhood complete with model homes and open for business. WTF? Seeing as how this bedroom community town is largely American Airlines employees, one has to wonder at exactly what kind of rocks the developers have in their heads.
And the barbeque? Very sad. This place used to be known far and wide for its ribs, but alas! they’re now outsourced out from a place in Arkansas. The Polish sausage was sliced into little chunks, and likewise probably came to the restaurant in a five-gallon bucket. The pulled pork ain’t pulled, the fried olives are gone from the menu, along with the bacon from the green beans. And the place was less than half full. Bloody hell. Say it Will, things ain’t what they used to be, and probably never was.
http://thecollegeinvestor.com/ The College Investor

I think the housing market is in direct correlation with the labor market recovery in various areas. As employment trends change, so will homeownership.
CLO

It’s important to remember that consumer will not spend or borrow until they can fix their balance sheet first and see an increase of their real wages. As long as we have high unemployment, and stagnant income, I don’t see much the Feb can do to revitalize the housing market. All the money is sitting in the bank because people have bad credit from the over-borrowing in the past. We don’t have a liquidity problem. We have a credit problem plus an unemployment problem.
- http://www.dqydj.net/ PK
  
  Check out the article from today – we’re finally seeing increases in PCE adjusted income. How does that affect your forecast? Do you still see this as an access to credit and unemployment problem?

Home Price Recovery and the Federal Reserve

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