First, let's be clear about one thing. Federal Reserve monetary policy is no substitute for an appropriate and very much needed sound fiscal policy.
With respect to fiscal policy, government spending must be reduced and private sector driven economic growth must be encouraged to resume at a reasonable pace. The question, of course, is how to make that happen.
In that area of fiscal policy, the Federal Reserve isn't getting any help whatesoever from the President and Congress with respect to getting our economic "house" in order. My view on how to do that is quite is simple. Tax rates should be reduced across the board, loopholes should be closed for the high earners, and government spending should be reduced concurrently.
That's the path to more MOM and less OPM. More market based economic activity and less monopolistic cronyism based government spending. And more self reliance and less government knows best collectivism.
But since that hasn't happened, at least not yet, that doesn't mean the Fed can sit on the sidelines. Its clear mandate is to prevent high inflation and promote stable employment. That walk and chew gum responsibility is called a dual mandate. Contain inflation while creating jobs.
In the short term, QE3 won't interfere with the Fed's dual mandate. In the longer term, however, the Fed is playing with fire. Printing more money means more inflation at some point down the road. But we're in the midst of an economic mess of epic proportions and the jobless rate won't go down unless economic activity picks up. And that brings us back to housing as an essential piece of that economic recovery story.
With that in mind, let's acknowledge that most economic recoveries historically have been led by housing. It's a familiar story. As housing prices increase over time, a pricing bubble builds, the Fed raises interest rates to high enough levels to stop the housing price spiral, housing prices stabilize or even fall, unemployment rises as a result of the recession that occurs, and then the process reverses itself. Then rates come down, more houses are built and bought, economic and employment activity picks up, the recession ends and we're back on track. At least that's the way it used to work.
This time really is different from the economic woes of the late 1970s and early 1980s when inflation was the immediate problem and interest rates were driven to all time highs. At those heights, reducing rates was a simple matter for the Fed. Not so today with rates at historic lows.
This economy is struggling from too much government, too little economic growth, too much debt and a globally overindebted and ultra competitive market place.
BUT housing still has a big POTENTIAL role to play as we climb from the depths of the recession. So the Fed is trying to come to the rescue of housing with its new bond buying program announced this past week. Will it work?
We'll see. However, a few big problems remain in addition to interest rates --- the creditworthiness of potential buyers, the ability to make substantial down payments on home loans, and the willingness of potential buyers to step forward, to cite just a few. On the other side, there's the willingness of under water sellers to take a loss and sell at today's market price for homes.
In other words, we have a problem with real world indebtedness, uncertainty, confidence and affordability. And it's very much one which monetary policy alone can't solve. But that doesn't mean it can't help --- at least in the short term.
Fed Faces Hurdles in Bid to Save Housing explains the situation well:
"The Federal Reserve's new effort to lower mortgage rates is aimed at boosting
housing markets that are finally showing signs of life, but the help could be
limited by tight credit standards and a shrunken mortgage industry.
Rates on the 30-year fixed mortgage could fall in coming weeks to about
3.25%, said Mahesh Swaminathan, senior mortgage strategist at investment bank
Credit Suisse, down from current levels around 3.55%. That would push rates to
their lowest recorded levels, down from 4.09% one year ago and 6.35% four years
ago, when the financial crisis erupted.
Housing normally serves as a key channel for Fed efforts to jump-start the
economy through low interest rates. That hasn't happened this time because many
would-be borrowers have too much debt to get a mortgage, and banks have
tightened credit standards since the financial crisis. Demand for mortgage
applications to buy homes has been muted this year, even though rates have
tumbled.
Housing "has been one of the missing pistons in the engine here," Fed
Chairman Ben Bernanke said at a news conference Thursday.
But with new-home construction and home prices picking up, housing could
gradually provide more power.
"To the extent that home prices begin to rise, consumers will feel wealthier,
they'll feel more disposed to spend," Mr. Bernanke said. "People may be more
willing to buy homes because they think that they'll make a better return on
that purchase."
Low rates help housing by allowing buyers to take on slightly more debt
without boosting their monthly payment. A rule of thumb holds that every
one-percentage-point decline in mortgage rates effectively lowers the cost of
buying by roughly 10%.
Low rates also typically spur mortgage refinancing, which lowers a borrower's
monthly payments, freeing up cash that can be spent on other goods and services.
As rates fall, borrowers also may find they are able to cut several years off
their loan term by refinancing into a 15- or 20-year mortgage. That could help
underwater borrowers rebuild equity faster. . . .
However, several hurdles continue to impede the ability of low rates to
stimulate a housing recovery. . . .
The new program will increase the Fed's role in the market for
mortgage-backed securities. Its share of mortgage-bond purchases will rise to
about 55% of all monthly bond issuance by year-end, up from about 24% last
month, according to strategists at J.P. Morgan Chase & Co.
"They're landing in the market with a giant footprint. For all intents and
purposes, they are going to take over the market for the next two to three
months," said Jim Vogel, an interest-rate strategist at FTN Financial.
The Fed's past rounds of asset-buying focused on Treasurys or on
mortgage-backed securities that investors weren't interested in buying. This
time, however, the purchases could be more disruptive to bond markets because
mortgage securities have carried high yields and many buyers will have trouble
finding alternative investments when yields fall.
Still, given the headwinds facing the housing sector, the central bank
appears willing to tolerate any uncertainty that could create in the
mortgage-bond market if it helps provide more support to the economy. The latest
purchases should "provide a smooth, longer bridge for home prices to continue to
improve, not just in bursts when rates initially tick down," Mr. Vogel said."
Summing Up
People should consider one additional very important but seldom if ever mentioned fact about all this --- what goes up must come down, and vice versa. That "up and down" factoid applies to both home prices and interest rates as well.
So now the Fed will be keeping borrowing rates extraordinarily low for a considerable period of time to entice people to borrow and buy homes. Eventually rates will have to rise back to something approaching normal. When they do, home prices relative to today will have climbed. At that point, however, interest rates will have risen as well.
Rising interest rates, all other things being equal, will result in lower home prices. So if you're a buyer, please don't buy as an investment. Buy because you intend to live in that home for a long time.
And always remember the immediate ATTRACTIVENESS and longer term DANGER of being able to borrow more money than what we'll be able to repay with relative ease.
We don't need another inflationary housing and related household debt bubble and their inevitable aftershocks anytime soon, if ever.
Neither individually nor as a nation. Been there, done that.
Thanks. Bob.
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