Apr262017
How does housing benefit when the federal reserve prints money?
When the federal reserve prints money to buy mortgage-backed securities, it lowers mortgage rates and allows potential buyers to borrow more money and push house prices higher.
The federal reserve sets policy in meetings of the Federal Open Market Committee (FOMC), a group of bankers. The FOMC sets target interest rates and directs its traders to either buy or sell securities to meet interest rate targets. When the federal reserve buys Treasuries, the price goes up, and interest rates go down. When the federal reserve sells Treasuries, the price goes down, and interest rates go up.
Prior to the financial meltdown in 2008, the federal reserve only bought short-term Treasuries, but in an effort to rescue housing, they began an unprecedented campaign of buying 10-year Treasuries and mortgage-backed securities in order to drive down mortgage interest rates.
It’s important to remember that the federal reserve had never done anything like this before. However, with the member banks of the federal reserve exposed to a $1 trillion in unsecured mortgage debt, stimulating housing to make prices go up was considered essential to save the banking system — or at very least preserve the jobs and bonuses of powerful banking executives.
Printing Money
When the federal reserve buys a Treasury note or a mortgage-backed security, unlike an ordinary bank or citizen, it doesn’t have the money stored in some account it uses to buy. When the federal reserve buys, it merely prints money. That money didn’t exist prior to the federal reserve’s purchase.
There are limits to how much money the federal reserve can print. Ultimately, the total amount of money in circulation represents the total value of goods and services in the economy. If the federal reserve prints too much — and there is always pressure to print free money — the excess causes price inflation.
During the housing bubble, lenders created a large amount of mortgage debt. Ostensibly, this was backed by the “value” they were creating in housing. Unfortunately, since this value was not real, the mortgage debt bloated the money supply and created a false economic boom.
Monetary Deflation from the Housing Bubble
The collapse of the housing bubble caused a great deal of mortgage debt to vanish. When banks make loans that don’t get repaid, and they cannot recover the loan amount through foreclosure and resale of the asset, deflation results. In effect, the losses unprint money. The main reason we didn’t see inflation from the federal reserves endless quantitative easing (fancy term for printing money) was that the new money printed was merely offsetting money destroyed by bank write downs from consumer deleveraging. (Also, some inflation was exported to countries with a currency pegged to the dollar.)
Yields on long-term debt
The federal reserve bought 10-year Treasuries and mortgage-backed securities specifically to lower mortgage interest rates and reflate the housing bubble. Private investors also purchased these securities because despite their low yields, they provided better returns than competing investments.
However, investing in longer-term debt while interest rates were at record lows was characterized as “picking up nickels in front of steamrollers” because the resale value of these instruments plummeted when interest rates began to rise. What investors made in yield they surrendered when values dropped later on.
Investors aren’t stupid. Most know this, so these investors have their finger on the eject button, and the herd is easily spooked. The slightest hint of a move higher in rates causes investor panic, wild selloffs, and short-term spikes in interest rates.
The 2013 spike in mortgage rates was caused by the rumor that the federal reserve might taper off its purchases of mortgage-backed securities. Merely the rumor, not any announcement of a change in policy, caused the interest rate spike.
The 2016 spike in mortgage rates was caused by the impression that Donald Trump’s policies would be inflationary. Bonds sold off causing a rate spike right after Trump’s election, long before he could actually implement any inflationary policies.
After a few weeks of sitting in cash, these investors started looking for investments that provided yield. When none were available, they piled back into longer-duration debt, prices rose, and interest rates fell again. This skittish flow of money in and out of the bond market creates much volatility in rates, and at some point, investors will find superior competing investments, and the money will not flow back into these bonds. When that happens, rates will steadily rise.
Why do we know mortgage interest rates will rise?
Interest rates are near record lows, it’s difficult to imagine they will go anywhere but up. A simple reversion to the mean suggests that much. However, the case for rising rates is anchored in something much more tangible. An astute reader posed the question in the comments recently, “Since the fed has been buying the overwhelming majority of Treasuries and mortgage-backed securities, when they taper off their purchases, won’t there be some effect of the loss of a major buyer of these assets?”
Take away the major buyer of any asset, and prices will likely fall, perhaps a great deal. Remember, falling bond prices mean rising interest rates. Unless some major sovereign power or central bank steps in to take up the slack, prices will fall and interest rates will rise.
Icarus and endless quantitative easing
Rising interest rates hurt the banks by making it more difficult to reflate the housing bubble. It makes life difficult for our government issuing all this debt the federal reserve buys. Rising interest rates make the debt-service payments on the US debt onerous. So why not print money indefinitely?
Printing money is dangerous. The only reason the federal reserve gets away with it now is because investors don’t believe their printing is causing inflation. Realistically, as long as we were still deleveraging and writing down copious amounts of mortgage debt, that was probably true.
Investors satisfy themselves with 2% yields on 10-year Treasuries as long as they believe the currency is losing value at less than 2% per year from printing money. In fact, with monetary deflation caused by debt deleveraging, many investors perceive that real interest rates (those adjusted for inflation) are still quite high. In short, as long as we have deflation, low yielding treasuries are a good investment.
Once consumer deleveraging stops and money is no longer being destroyed, further quantitative easing will be inflationary, and if investors believe inflation will exceed the yield they are getting on long-term debt, they won’t buy it. The lack of buyers causes bond prices to drop and interest rates to rise. This change in belief is was sparked the 2016 selloff after Trump’s election.
Icarus is a character from Greek mythology. He wanted to escape the island of Crete, so his father fashioned him wings made of wax and feathers and instructed him not to fly too close to the sun or the wax would melt and he would crash. Icarus did not heed his father’s warning, and when he flew too high, the wax melted, the feathers fell off, and he crashed back down to earth.
Quantitative easing is much like the flight of Icarus. When the economy got really bad, it was arguably the only way out of our predicament. If they print just the right amount, we can fly to safety. However, if they print too much, if they fly too close to the sun, the melting rays of inflation will cause investors to stop buying bonds, the federal reserve would lose control of long-term rates, and we could have a complete meltdown of the mortgage and housing markets.
This more than theoretical imagining. This is a very real danger.
If the federal reserve prints too much money, inflation expectation will cause investors to abandon the bond market, bond prices would crash, interest rates would spike, nobody could afford today’s house prices at 10% interest rates, and the resulting housing market crash would rival 2008.
This was a very real concern during the post-crash era. Fortunately, the worst fears never materialized — at least not yet.
Case-Shiller: Home prices hit fourth consecutive all-time high
Home prices continued to expand in February, hitting their fourth consecutive all-time high, according to the S&P Dow Jones Indices.
The S&P CoreLogic Case-Shiller Indices, a national measure of U.S. home prices, increased both month-over-month and year-over-year in February. The National Home Price NSA Index, which covers all nine U.S. census divisions, increased by 5.8% in February, up from last month’s 5.6% increase.
Similarly, the 10-City Composite increased 5.2% annually, up from 5% in January, and the 20-City Composite increased 5.9% from last year, up from 5.7% last month.
http://www.housingwire.com/ext/resources/images/editorial/Kelsey-Thompson/Charts2/Screen-Shot-2017-04-25-at-75854-AM.png
First American: Home affordability slips in February
A new report from Black Knight Financial Services showed home prices hit a new high in February, so it comes as no surprise that First American Financial Corp.’s latest report shows affordability slipped during the month.
Real home prices increased 0.7% from January to February, according to First American’s index. This marks an increase of 11% year-over-year.
“The lack of homes listed for sale is causing unadjusted house price growth to remain strong,” First American Chief Economist Mark Fleming said.
“Additionally, increasing interest rates are reducing consumer purchasing power,” Fleming said. “The result is a substantial year-over-year increase in the real price of homes.”
The RHPI measures the price changes of single-family properties throughout the U.S. adjusted for the impact of income and interest rate changes on consumer house-buying power over time and across the United States at national, state and metropolitan area levels. Because the RHPI adjusts for house-buying power, it also serves as a measure of housing affordability.
So while Black Knight’s report showed home prices hit an all-new peak, affordability remains well below pre-crisis levels.
According to First American’s index, real house prices remained 32.8% below the housing boom peak in July 2006 and 9.7% below the level of prices in January 2000.
“Most of the markets we follow experienced double-digit real house price increases in February, compared with a year ago,” Fleming said. “The main story in most markets this spring is the lack of supply.”
“Combined with unfaltering demand, the lack of supply continues to pressure unadjusted prices higher in one of the strongest spring sellers’ markets seen in recent memory,” he said. “Even so, it’s important to note that wages continue to grow and the level of affordability in most markets remains high by historical standards.”
Greenspan proves he was and still is an idiot.
Ex-Fed Chairman Greenspan: Get rid of Dodd-Frank and watch economy and stocks soar
Former Federal Reserve Chairman Alan Greenspan told CNBC on Thursday the prospect of getting rid of the Dodd-Frank banking regulations has been a driver of higher stocks and would continue to be.
“If you get rid of Dodd-Frank, it’s going to have a very significant positive impact on the economy,” he said on “Squawk on the Street,” from the sidelines of the IMF-World Bank meeting of finance ministers in Washington.
“In my judgment, that’s where the surge in the stock prices has come from. It’s very difficult to find anything other than that, which I find really positive,” argued Greenspan, who served nearly two decades as Fed chairman from 1987 to 2006.
In February, President Donald Trump ordered the Treasury and other financial regulators to review the banking and consumer finance rules created under Dodd-Frank, the 2010 law crafted in response to the financial crisis two years earlier.
The tighter rules aimed at preventing taxpayers from having to bailout “too big to fail” banks in the future included higher rainy day capital requirements, which critics say stifle lending and hurt economic growth.
WILL TAXING FOREIGN BUYERS COOL ONTARIO HOUSING MARKET?
Cities have become increasingly globalized in the last two decades, with investors from all over the world purchasing second and third (and fourth and fifth) homes in top cities where real estate is considered an investment.
As investors purchase more and more of these homes, there are fewer homes available for local residents, which ultimately pushes up the price. Ontario is hoping to subdue the effect of that on Toronto, where home prices have risen 33% in just a year, with a 15% tax on non-residents of Canada who purchase a home in the city. The proposal follows the actions of British Colombia, though evidence of the law’s effectiveness is not clear.
While price growth in Vancouver has slowed since its introduction — prices fell on average 1.9 percent last month — the market there was softening well before the tax was imposed. And real estate industry experts said they anticipated that prices would rise again soon.
New home sales soar above market expectations
New home sales soared in March, beating out experts’ expectations, but new homes for sale dropped, according to the report released Tuesday by the U.S. Census Bureau and the U.S. Department of Housing and Urban Development.
Sales of new single-family homes in March 2017 came in at a seasonally adjusted annual rate of 621,000, according to the report. This is an increase of 5.8% from February’s 587,000 and is 15.6% higher than March 2016’s 537,000 sales.
“New home sales increased to an annualized rate of 621k, well above the Street expectations of 587k,” iServe Residential Lending director of capital markets Brent Nyitray wrote in a note to his clients. “New Home Sales is a notoriously volatile number, but it looks like the spring selling season is off to a good start.”
The median sales price of new homes sold in March increased to $315,100, up from $296,200 in February.
All that people really need to know and understand about the QE/ZIRP era….
Printing money is NOT really designed to benefit housing per se, it’s designed to keep the financial LOSERS in the game.
As far as politicians care, if the loser is an employer, keeping them in the game keeps people in jobs, so supporting losers is a necessary evil.
I find it interesting that retail waited to implode after the bust. I wonder how many doomer retailers stayed in business for another five to ten years simply due to cheap debt and an overabundance of capital.
I have been reading your articles for a few years now but this will be my first post (or share). For a real estate group to generate an article like this it is truly remarkable (to me). Thank you for all you do.
Sorry, I thought the link would attach. Rookie mistake 🙂
http://www.paragon-re.com/3_Recessions_2_Bubbles_and_a_Baby
Thank you, Mr. D. And thanks for sharing the link. What’s even more remarkable is that their own analysis shows this rally is long by historical standards. A truthful analysis like that might make some of their buyers think twice.