by Mario Rizzo
Reality is more complex than our models. Free-market forces are asserting themselves but the Fed is also intervening and trying to affect those forces. Real-world data is the result of both factors.
The Commerce Department has issued some new data showing that house sales are rebounding (but still off their year-ago levels) and that house prices are falling. This is to be expected as supply and demand begin to equilibrate.
On the other hand, demand is being stimulated by Fed purchases of MBS. As of March 18, 2009 the Fed had $236 billion in such securities on its balance sheet. In addition, a $8,000 tax credit for first-time home-buyers was included in the stimulus law. More purchases of MBS are forthcoming. This should cause mortgage rates to fall further (although some of that fall is already being seen). And who knows what is coming after that?
(The tax credit will expire in December; that will reduce demand. I doubt this will be a big factor either on the upside or the downside.)
So whatever equilibrium the market is tending toward, it is not a long-run sustainable one. This is because real interest rates will rise in the few years due either to inflation or the Fed’s sales of MBS to prevent inflation.
If the first is the mechanism, then we shall probably see another housing bubble bursting. This is because the Fed will not begin selling securities until it sees sign of overall inflation (and not simply price rises in particular markets). This will be too late to prevent a new housing boom.
If the second is the mechanism, then the Fed will have simply succeeded in slowing down movement to the eventual lower-price equilibrium.
Overall, it is good news that housing prices are falling and sales rising. Yet the Fed will manage to turn this good news into bad: just the opposite of the “Keynesian miracle” — bread into stones.