I remember when I knew for sure that soaring home prices had gone beyond “froth” to attain bubble status. It was sometime in 2004, and the alert landed in my inbox.
A public-relations firm sent me a pitch for a new website, condoflip.com, where one could buy and sell condominiums sight unseen. The idea that the average person’s largest store of wealth had succumbed to a no-lose gambling mentality was a good indication that this was no ordinary bull market.
Fast forward nine years, and the residential real-estate market, the traditional leader of the business cycle, is starting to shake off the combined effect of bad loans, falling home prices and tight credit, and is contributing to economic growth once again.
So imagine my surprise when I heard a radio commercial last week pitching a guide to flipping homes. Can’t be, I thought. The United States has had its share of asset bubbles during the three decades of the Great Moderation: a period of low, stable inflation. Usually history doesn’t repeat itself quite that quickly, at least not with the same asset class.
A Google search for “house flipping” produced everything from “House Flipping Basics” to a step-by-step “Beginner’s Guide” to a free “Flip This House” seminar. At least the Federal Reserve can claim partial success for fanning another housing bubble.
No, policy makers don’t say it quite like that. But consider their actions.
The Fed has done everything in its power to lower long-term interest rates, focusing more on the composition of its balance sheet than the size. It sold its entire portfolio of short-term Treasuries in exchange for longer-term notes and bonds. The maturity extension program concluded at year-end, but the Fed will continue to purchase $45 billion of longer-term Treasuries and $40 billion of agency mortgage-backed securities a month, indefinitely.
With the Fed’s help, 30-year fixed-rate mortgages fell to a record low of 3.3 percent. It’s now cheaper to buy than to rent a comparable property almost everywhere in the United States, according to real-estate website Trulia.com.
The only thing standing between interest rates and another real-estate bubble is sentiment (we have learned that house prices can and do fall) and tight credit, two not-insignificant hurdles. After a decade of lending to anyone with a pulse, banks are leaning in the other direction. But with the spread between banks’ cost of funding and mortgage-lending rates unusually wide, how long will it take for them to cash in?
While I was considering the possibility of condo-flip redux, I started to think about asset bubbles in general and the Fed’s new policy guidelines in particular. Is there anything in the array of squishy thresholds for raising interest rates that would provide an early warning system for asset bubbles?
An unemployment rate of 6.5 percent, maybe lower; a forecast of inflation — the Fed’s! — of no more than 2.5 percent one-to-two years out; and “well-anchored” inflation expectations. These are the conditions that must be met before the Fed begins the long slog to normalize interest rates.
Could asset prices get out of line under such a regime, threatening the economy and financial system once again? Recent history suggests it’s possible for the economy to be well within the Fed’s speed limits for inflation and unemployment with trouble brewing in asset markets.
For example, in 2003, the unemployment rate and the rise in the consumer price index averaged 6 percent and 2.3 percent, respectively. The Fed’s preferred inflation measure, the personal consumption expenditures price index excluding food and energy, increased a tame 1.5 percent that year.
Meanwhile, house prices, which had been increasing faster than the CPI since 1997, rose 10.7 percent. Undeterred, the Fed lowered its benchmark rate to 1 percent from 1.25 percent in mid-2003 even as the real funds rate, adjusted for inflation, wallowed in negative territory. I somehow doubt the new metrics would have helped the Fed to see what it missed under the old regime.
Asset bubbles would be less likely under a target of nominal gross domestic product, according to David Beckworth, assistant professor of economics at Western Kentucky University in Bowling Green. Even if faster productivity growth led to lower prices, “under an NGDP target the Fed doesn’t care if prices fall as long as nominal spending is stable,” Beckworth said.
I’m not convinced. Nominal spending was still rebounding from the 2001 recession in 2003 and wouldn’t have telegraphed easy monetary policy. And house prices per se aren’t included in any of the inflation indexes, which use the imputed rental value of a home instead.
Unless bubbly asset prices manage to insert themselves into the unemployment rate, the Fed’s inflation forecasts or the market’s inflation expectations, it’s hard to see how the new guidelines will do anything to improve the Fed’s clairvoyance.
Baum, author of “Just What I Said,” is a Bloomberg View columnist.