How Much Does the Fed Distort the Housing Market?

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A recent slew of reports appear to be pointing towards a recovery in the housing industry. Home prices in the United States are rising, while mortgage applications recently hit a new high for the year. However, policy actions greatly distort the true housing picture and its rocky foundation.

Headlines are building a bullish case for one of the nation’s most closely watched industries. According to CoreLogic, a data analysis firm, home prices logged their biggest annual jump in October since June 2006. The firm’s home price index increased 6.3 percent, compared to October a year ago. The Mortgage Bankers Association also recently reported that applications for U.S. home mortgages increased 4.5 percent in the week ended November 30.

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Although there are statistical improvements, they come with a major caveat. The Federal Reserve is influencing financial markets across the board through its QE programs and Operation Twist. One of the known effects of central bank money printing is lower interest rates, which enable borrowers who can still obtain a loan, afford higher prices. It also expands the pool of homebuyers. The effect is quite dramatic when looking at historical and current mortgage rates.

The chart above comes from Iacono Research and details the massive distortion caused by artificial low rates. Using a constant mortgage payment of $1,100 per month, a 30-year mortgage with a 3.31 percent interest rate will finance a house at nearly double the price the 40-year average mortgage rate would. Of course, property taxes and insurance would add to the cost, but it provides a simple example to see the impact of lower interest rates.

Tim Iacono writes, “While there are clearly other factors involved, it is the Federal Reserve’s asset purchase program that is largely responsible for these freakishly low rates (it is one of their stated policy objectives) and, while the central bank has promised to keep rates low for a long time and to continue buying mortgage-backed securities indefinitely, those actions are by no means guaranteed.”

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