Tuesday, October 18, 2005

Fed's Yellen: "Bubble element" to housing

by Calculated Risk on 10/18/2005 03:09:00 PM

UPDATE: Dr. Thoma reviews the rest of Dr. Yellen's speech.

UPDATE2: Federal Reserve Vice Chairman Roger W. Ferguson, Jr. also spoke yesterday: Economic Outlook for the United States. Here are his comments on housing:

"... clearly one concern ... was the ongoing rise in home prices and the possibility that this phenomenon is unsustainable. House prices have risen to levels that, in some areas of the country, seem high relative to the economic fundamentals. The market for second homes seems especially strong, raising the fear that some homeowners are speculating on further increases in home prices. The greater use of innovative forms of mortgage finance adds to the concern that the residential real estate market may well be vulnerable to a flattening of home prices, and in certain markets, perhaps a decline. I do not think that a significant and widespread drop in home prices is the most likely outcome, but the situation will require careful monitoring in the months ahead."

San Francisco Fed President Janet Yellen spoke in Salt Lake City today. Although generally optimistic, Dr. Yellen made a few cautionary comments:
"My medium-term outlook, before Katrina, was for growth averaging a pace sufficient to keep the economy operating in the vicinity of full employment, albeit with notable risks, particularly relating to energy prices and housing..."
Yellen talked about energy and inflation, but one of her main concerns was housing:
" ...there are downside risks to economic growth relating to the housing market. This sector has been a key source of strength in the current expansion, and the concern is that, if house prices fell, the negative impact on household wealth could lead to a pullback in consumer spending. Certainly, analyses do indicate that house prices are abnormally high—that there is a "bubble" element, even accounting for factors that would support high house prices, such as low mortgage interest rates. So a reversal is certainly a possibility. Moreover, even the portion of house prices that is explained by low mortgage rates is at risk. There is a controversy about just why the rates have stayed so low. Over the past year, the Fed has raised the federal funds rate significantly. Normally, long-term interest rates also rise with increases in the expected path for the federal funds rate. But, long-term rates—such as those on 30-year fixed rate mortgages—have actually fallen over the period. This is what Chairman Greenspan has labelled a conundrum because there seems to be no convincing explanation for it. So, we can't rule out the possibility that they would rise to a more normal relationship with short-term rates. This obviously might take some of the "oomph" out of the housing market. My bottom line is that while I'm certainly not predicting anything about future house price movements, I think it's obvious that a substantial cooling off of the housing sector represents a downside risk to the outlook for growth."