Will quantitative easing work to reduce interest rates further—or at least keep them low for the time being—and will that stimulate the moribund housing sector?
The recent announcement by the Federal Reserve that it will purchase $600 billion of longer-term treasuries—known as quantitative easing, or QE2—is clearly aimed at the housing market as well as at commercial lending in general. The Fed is targeting maturities in the seven- to ten-year range—those that most clearly affect mortgage rates—with the hope and expectation of further reducing already low mortgage rates.
This raises many questions, two of the most important ones being: Will it work to reduce interest rates further (or at least keep them low for the time being)? And: Will that stimulate the moribund housing sector?
As to the first question, there is a lively debate among economists and analysts, a debate that has been joined by politicians and leaders of foreign countries. Creating $600 billion of demand for these securities, more than the amount the U.S. Treasury is planning to issue in its target range, should, on its face, drive up the price for those securities and thus reduce their rates. Should, that is, unless the impact of pumping so many new dollars into the markets drives down the price of the dollar on international currency markets to a point where holders of treasuries begin to sell them in large amounts in order to move their funds to stronger currencies. If this happens, the rates on treasuries could actually rise, a perverse result from the Fed’s action, which is what has happened as of the time of the writing of this article. There also is the fear that flooding the market with dollars could trigger inflation, forcing the Fed to drive interest rates up. Moreover, there is concern that the falling dollar could lead to a global currency war of the type last seen in the 1930s, as each nation tries to weaken its currency to support its exports, including controls over capital flows and rising trade barriers. As of the time this article was written, however, the dollar remains strong, largely as a result
of fears for the euro.
Which way, then, will mortgage rates move? At the moment, after a slight uptick, they are stable and it seems probable that they will be flat or down into the first quarter of 2011; after that, it is harder to project as more factors come into play over time.
This leads us to the second question: What will be the impact of low or falling rates on the housing market? Housing production is at the lowest it has been for decades at 600,000 new units a year, a number that is still higher than household formation at 400,000 a year. Home prices as measured in October 2010 by the S&P/Case-Shiller Home Price Index are higher than a year ago. This, however, is due to the rise in housing prices earlier in the year caused by the housing tax credit; since then, home prices have been dropping over the summer and are likely to be negative for the year as a whole.
Local markets, of course, move to their own beat, but only five cities in the Case-Shiller 20 City Index rose over the summer. The Los Angeles, San Diego, and San Francisco housing markets, which had strong spring seasons and where prices are still well above where they were a year ago, are now falling. Prices in the New York market, on the other hand, are rising gradually though they are basically flat against last year. Washington, D.C., continues to add to its gains from the spring and is up year over year. Prices in Chicago, while improving, are still down year over year, and Las Vegas, well down for the year, has at least seen home prices stabilize. The only other city to show some growth over the summer is Detroit, which is flat year over year; because it never experienced the housing boom, it has avoided the bust.
By and large, though, home prices have resumed their downward trend nationally. Significantly, this is occurring despite mortgage interest rates already at 60-year lows. In short, demand for housing is barely existent despite a historic drop in home prices and rock-bottom interest rates. What gives? Most analysts attribute this remarkably low demand to headwinds of the overall poor economy:
- persistently high unemployment, especially among young would-be first-time homebuyers in their 20s and early 30s;
- falling wages and continuing uncertainty over job stability;
- the inability of those homeowners who owe more on their homes than they are worth in the market to sell their homes and buy a new home (estimates are that 25 percent of all homes with mortgages are “underwater";
- ongoing foreclosures at historically high rates, the recent moratoriums by banks on foreclosures notwithstanding; and
- an overall shift from spending to saving on the part of consumers.
There also is a huge oversupply of vacant housing in the market today—5.5 million homes by some estimates, which is at least 2 million more than the precrash norm. As a result of all of this, the homeownership rate continues to fall, down to 66.7 percent as of the third quarter of 2010.
Given all this, will driving mortgage rates down further spur demand for housing? Probably not, though allowing mortgage rates to climb would likely further stall housing markets and push out a possible housing recovery (and recovery of the economy and employment numbers) even further. Chances are then that the Fed’s move is a sound defensive play, but not one likely to put points on the board and drive up demand for housing and other major goods. Expect housing prices to continue to fall through this year, accompanied by housing production that remains at its present, depressed levels.
