The Federal Reserve and Home Prices

June 1, 2021

Orion’s brokers have been reporting home prices that are defying gravity for several months. Some are wondering if the Fed's policy of buying mortgage-backed securities fueling the rise in home prices. At least some are making that argument: The Fed's buying is pushing mortgage rates lower than they would otherwise be, and that is permitting people to buy more house than they otherwise could.

 

Boston Fed President Charles Evans thinks that the MBS purchases might be unnecessary at this point, and that the Federal Reserve's asset purchases artificially lower interest rates and financing costs, which reinforces the buyer's need to pay higher prices. It is even further detrimental because the higher price means that the buyer is borrowing more and taking on additional leverage.

 

Orion’s brokers should look beyond the headlines, however. Residential lenders closed roughly $4 trillion in origination last year (according to the MBA), so it is hard to imagine that $40-100 billion a month is moving the needle all that much. I have to imagine that competitive behavior between the big originators is having a much bigger impact. Many others think it is a stretch to link the Fed's buying to home price appreciation. That is due to a fundamental supply / demand imbalance in the housing market, driven by over a decade of under-building. Once the COVID-19 driven supply shocks work their way through the system, we should see housing starts return to a level to meet the demand out there.

 

Of course the bigger question is whether the Fed's MBS purchases are necessary in the first place, and originators were fending off margin calls from their brokers on a daily basis a year ago, which was partially driven by the Fed's buying.

 

That said, does the Fed's policy in general push up asset prices? Yes, the basic laws of supply and demand dictate that. But it goes back to the dual mandate, which is a law passed over 40 years ago, stating that the Fed must maximize employment in the context of controlling inflation. While a well-intentioned policy, like most everything the government does, there have been unintended consequences. In practice, the policy tells the Fed to keep the pedal to the metal as long as inflation (as measured by consumer prices) is behaving.

 

What about asset price inflation? Doesn't count. The dual mandate coincides with the mother of all bull markets in stocks, bonds, and real estate. The Fed inflated a stock bubble in the 90s, and inflated a residential real estate bubble in the aftermath. Orion believes that the Fed has done adecent job, playing the hand it has been dealt, but will probably take a very hard look at taking its foot off the gas by scaling back on purchasing securities as the economy heats up.


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