Home Price Rebound Creeps into Policy Debate of Bubble-Wary Fed
Real estate broker Warren Teller watched as the housing market in Richmond, Va., slowed dramatically eight years ago. Today, he's witnessing a reversal.
"We're in the best position that we've been in since probably 2006 and 2007," said Teller, 41, who's even seen bidding wars and appraisal-topping purchase prices. "As far as prices, we're back on track with where we were before the bubble burst, and as far as inventory, we're down."
As residential real estate prices stage a comeback, Federal Reserve policy makers may be gaining an extra motivation for lifting interest rates for the first time in nearly a decade: They don't want to let recovery evolve into excess.
San Francisco Fed President John Williams said in a speech last week that he sees "signs of imbalances" emerging in asset prices — especially real estate. After saying that conditions haven't yet reached a tipping point, he recalled that in the mid-2000s it was too late to "avoid bad outcomes" by raising interest rates once the housing boom was in full swing.
Williams told reporters that his housing market warning is "not about fighting bubbles, or trying to deal with financial stability" — it's more a response to why interest rates need to rise even though inflation remains low. "The reason you don't just let an economy rip — let it grow, and grow, and grow, and just see what happens, is because that usually ends badly," he said.
Williams' concern about how Fed policy might interact with asset-price stability could be a sign that bubble risks are gaining weight, at least among some policy makers. That attention comes just after the central bank put off an interest-rate increase at its Sept. 16-17 meeting in what both Williams and Atlanta Fed President Dennis Lockhart have characterized as a close call.
"He seems to be suggesting that if you are worried about overdoing it, the time to worry is now," said Stephen Stanley, chief economist at Amherst Pierpont Securities in Stamford, Conn. "It's not a central decision criterion, but if the decision is close, it can tip the balance."
Williams' colleagues Esther George, president of the Kansas City Fed, and James Bullard, the St. Louis Fed president, have warned that keeping rates low for too long could lead to asset bubbles. Still, his comments are significant because his views are generally aligned with the centrists on the committee.
In his speech, Williams specifically cited that the price- to-rent ratio, which measures how expensive housing is relative to what one could rent similar units for, has rebounded to 2003 levels.
The measure is analogous to the price-earnings ratio for stocks, said San Francisco Fed research adviser Kevin Lansing, and "we know that when price/earnings for stocks gets way above its long-run average, that's a reason to worry about bubbly asset prices."
"The claim was, in 2002-2003, that the Fed left interest rates too low for too long," said Morris Davis, academic director of the Center for Real Estate Studies at Rutgers Business School in Newark, N.J. Now, "what Fed policy makers will ask is: what is the natural place that this rent- price ratio should be?"
The ratio hasn't yet reached the danger zone, Lansing said, because conditions didn't really get frothy until 2004 or 2005. Even so, the Fed is acutely aware that waiting for unbalanced conditions to form can mean waiting too long: In 2009 then-San Francisco Fed President Janet Yellen said what had "become patently obvious is that not dealing with certain kinds of bubbles before they get big can have grave consequences."
It's also true that rising prices paired with low interest rates can encourage risky lending, Lansing said. Even so, the run-up in leverage that came alongside home price appreciation back in the 2000's isn't replaying yet, a fact in which Fed officials can take heart.
"Now we have a few little pockets, areas of concern, but they seem to be pretty small, and the leverage that we see in the economy now doesn't seem to be very pronounced," New York Fed President William Dudley said last week at a Wall Street Journal forum, responding to a question about whether he's worried that bubbles are forming in areas including real estate and automobiles. Conditions "are not any reason for a great level of concern at this point."
Dudley isn't alone in being untroubled by asset prices: Chair Yellen called the residential real estate market "very depressed" in September, referencing housing starts, which remain subdued. In its July semiannual report to Congress, the Fed said residential valuation measures were close to historical norms but mentioned that "valuation pressures in commercial real estate are rising as commercial property prices continue to increase rapidly."
From his seat at the San Francisco Fed, Williams has a bird's-eye view of one of the hottest housing markets in the country, which may inform his assessment. The Bay Area is so expensive that some — including Jeff Hanlon, 41, and his husband Rem Jurado, 25 — are cashing out.
"The prices have skyrocketed, and what you could get for the money was basically soul-destroying," said Hanlon, who moved to Richmond this March, buying a $710,000, five-bedroom house with nine fireplaces, 3.5 bathrooms and hardwood floors instead of the one-bedroom condo he thought he could afford in the Bay Area. Hanlon and a previous partner sold their property last year into what he called a "voracious market."
Even if imbalances are arising, there may be a limit to what the Fed can do with monetary policy to prevent real estate from overheating.
Economists at the San Francisco Fed earlier this year quantified how responsive mortgage lending and home prices are to interest rates and found that the federal funds rate would have needed to increase by about 8 percentage points in 2002 to keep house prices on trend.
"Preemptive interest rate policy would have been extraordinarily tight in 2002 then would have gradually abated to around the level eventually reached in June 2006," the economists wrote. "By our calculations, such a large increase in interest rates would have depressed output more than the Great Recession did, roughly speaking."
Even so, the Fed has learned "sobering message" that it's hard to contain an existing crisis after the housing crash, said Stephen Oliner, a scholar at the American Enterprise Institute and former Fed Board research director. That's given them a new focus on preemptive policy, even it only helps at the margin, he said.
"They can nudge things, and I think that's really about all," Oliner said, adding that policy makers are "acutely worried" about fueling asset bubbles with easy policy. "It's going to be something you hear about from more Fed officials."