The Fed Against Equilibration

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.


6 thoughts on “The Fed Against Equilibration

  1. The key to housing prices is not interest rates, but rather the value of the dollar. If the dollar falls, real estate prices will rise even if rates trend higher. Take a look at the data from the late 70s. Housing prices as measured by the CPI (and I believe they actually used house prices back then rather than imputed rent, but you can look at regional data on house prices as well) continued to rise even as mortgage rates rose into double digits. The dollar on the other hand was falling on a trade weighted basis and against gold. House prices didn’t peak until the 80-81 recession. House prices also rose again after that short recession, even with rates rising, until the double dip hit.

    House prices seem to act more like commodity prices which also tend to rise when the dollar is falling. Investors look for ways to protect their purchasing power during inflationary devaluations of the currency. As my friend John Tamny puts it, when the dollar is falling, people run to the real.

  2. Mario,
    Msm reporting of financial and economic data tends toward awful. New home sales did increase, but if you read the report, the margin of error is +-18%. Also, January was revised down further. Finally, housing data matters most in terms of YoY data (and as you note it is off (-40%)). In the spring sales always rise and in the fall they always decline.

    You’re right in your analysis of the situation, but I would advise against blindly believing that housing sales are increasing.

  3. two things:

    first, I’m a little unnerved that you’re using the word inflation to mean ‘rise in prices’ and not increase in money supply, which baffles semi-clear thinking.

    second – it would be nice to be able to distinguish buyers from investors in those increased sales numbers. I’d also like to get some numbers on how many of those properties were sold through foreclosure and short sales. It would also be at least interesting to get some numbers on how many people are walking away from their mortgages.

  4. “first, I’m a little unnerved that you’re using the word inflation to mean ‘rise in prices’ and not increase in money supply, which baffles semi-clear thinking.”

    Hmmmm. When the Fed purchases MBS it is increasing the money supply, which he mentioned several times. And when he says that the Fed won’t sell securities until there is an increase in inflation, he is saying the Fed won’t reduce the money supply until it sees price inflation.

    I didn’t have any trouble at all understanding what was said.

  5. Tom, thanks. I actually concocted a sarcastic response. Two seconds before I sent it, I re-read the post more attentively and got both Mark and your points. okay? okay.

    But I did want to remark that I don’t think it’s such a good thing that house sales are rising, because they’re being bought and sold at an artificially gov’t-subsidized level (both in terms of interest rates and the tax credit- in order of importance).

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