Should the Fed tackle the US property bubble?

(NYTIMES) – Mr Robert Kaplan, president of the Federal Reserve Bank of Dallas, has been nervously eyeing the housing market as he ponders the path ahead for monetary policy. Home prices are rising at a double-digit pace this year.

The typical house in and around the city he calls home sold for US$306,031 (S$415,835) in June, Zillow estimates, up from US$261,710 a year earlier.

Several of Mr Kaplan’s colleagues harbour similar concerns. They are worried that the housing boom in the United States could end up looking like a bubble, one that threatens financial stability. And some fret that the central bank’s big bond purchases could be helping to inflate it.

“It’s making me nervous that you’ve got this incipient housing bubble, with anecdotal reports backed up by a lot of the data,” said Mr James Bullard, president of the Federal Reserve Bank of St Louis. He doesn’t think things are at crisis levels yet, but he believes the Fed should avoid fuelling the situation, saying: “We got in so much trouble with the housing bubble in the mid-2000s.”

Policymakers don’t need to look far to see escalating prices, because housing is getting more expensive nearly everywhere. Buying a typical home in Boise, Idaho, cost about US$469,000 in June, up from US$335,000 a year ago, based on Zillow estimates of local housing values.

A typical house in Boone, North Carolina, is worth US$362,000, up from US$269,000. Prices nationally have risen 15 per cent over the past year, Zillow’s statistics show, in line with the closely watched S&P CoreLogic Case-Shiller index of home prices, which rose a record 16.6 per cent in the year through May.

Bidding wars are frustrating buyers. Agents are struggling to navigate frantic competition. About half of small bankers in a recent industry survey said the current state of the housing market poses “a serious risk” to the US economy.

Lawmakers and economic policymakers alike are hoping things calm down – especially because frothy home prices could eventually spill into rent prices, worsening affordability for low-income families just as they face the end of pandemic-era eviction moratoriums and, in some cases, months of owed rent.

Industry experts say the home price boom emerged from a cocktail of low interest rates, booming demand and supply bottlenecks. In short, it’s a situation that many are feeling acutely with no single policy to blame and no easy fix.

Fed officials face a particularly tricky calculus when it comes to housing.

Their policies definitely help to drive demand. Bond-buying and low Fed interest rates make mortgages cheap, inspiring people to borrow more and buy bigger. But rates aren’t the sole factor behind the home price craze. It also traces back to demographics, a coronavirus pandemic-spurred desire for space, and a very limited supply of new and existing homes for sale – factors outside of the central bank’s control.

“Interest rates are one factor that’s supporting demand, but we really can’t do much about the supply side,” Mr Jerome Powell, the Fed chair, explained during recent congressional testimony.

It’s an unattractive prospect to pull back monetary support to try to rein in housing specifically, because doing so would slow the overall economy, making it harder for the central bank to foster full employment. The Fed’s policy-setting committee voted to keep policy set to full-support mode, and Mr Powell said at a subsequent news conference that the economy remains short of the central bank’s jobs target.

But central bank officials also monitor financial stability, so they are keenly watching the price surge.

Demand for housing was strong in 2018 and 2019, but it really took off early last year, after the Fed cut interest rates to near-zero and began buying government-backed debt to soothe markets at the start of the pandemic. Mortgage rates dropped, and mortgage applications soared.

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That was partly the point as the Fed fought to keep the economy afloat: Home-buying boosts all kinds of spending – from washing machines to curtains to kiddie pools – so it is a key lever for lifting the entire economy. Stoking it helps to revive floundering growth.

Those low interest rates hit just as the housing market was entering a societal sweet spot. Americans born in 1991, the country’s largest group by birth year, just turned 30. And as millennials – the nation’s largest generation – were beginning to think about trading in that fifth-floor walk-up for a home of their own, coronavirus lockdowns took hold.

Suddenly, having more space became paramount. For some people, several rounds of government stimulus cheques made down payments seem more workable. For others, remote work opened the door to new home markets and other possibilities.

Home supply fell across the residential real estate market following the mid-2000s housing bust, as construction slumped thanks in part to zoning regulations and tough financing standards. Shortages in lumber, appliances and labour have emerged since the pandemic took hold, making it hard for builders to churn out units fast enough.

There are early signs that the market might be bringing itself under control, however. Applications for new mortgages have slowed this year, and existing home inventories have risen. Many housing economists think price increases should moderate later this year.

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People who get mortgages these days tend to have excellent credit scores, unlike that earlier era. Banks are also now much better regulated. But that isn’t to say that no financial stability risks hide in the current boom.

So what can the Fed do about any of this? Officials, including Mr Bullard, have suggested that it might make sense for the Fed to slow its monthly purchases of Treasury debt and mortgage-backed securities soon, and quickly, to avoid giving housing an unneeded boost by keeping mortgages so cheap.

Discussions about how and when the Fed will taper off its buying are ongoing, but most economists expect bond-buying to slow late this year or early next year. That should nudge mortgage rates higher and slow the booming market a little.

But borrowing costs are likely to remain low by historical standards for years to come. Longer-term interest rates have fallen even as the Fed considers dialling back bond purchases, because investors have grown more glum about the global growth outlook.

And the Fed is unlikely to lift its policy interest rate – its more powerful tool – away from rock bottom any time soon.

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