Written by Evan Gao '16
After the worldwide financial crisis of 2008, it would seem that everyone, especially those that have a powerful influence over our economy, has learned what it takes to prevent another crisis from occurring. Recently, however, at a time when we are finally gaining momentum in our economic recovery, there has been speculation that another housing bubble is beginning to grow that can be partly attributable to the choices made by the Federal Reserve.
One of the Fed’s current policies is quantitative easing, a monetary policy that is aimed at increasing the money supply through the purchase of securities from the market by the Fed. Currently, the Fed is well into its third round of quantitative easing, in which it plans to purchase $40 billion in mortgage-backed securities each month. The end date remains unclear as the policy is contingent on the strength of the economy. Nevertheless, the purpose of quantitative easing, ever since its inception in 2008, is to stimulate the economy through the lowering interest rates and mortgage rates. By keeping such rates low, the Federal Reserve hopes to fuel spending as well as hiring nationwide. Ben Bernanke has also been lowering interest rates in an attempt to spur consumer purchasing and investing. He wants companies to invest today instead of waiting until tomorrow.
Through these policies, the Fed is trying to alleviate the effects from the crisis half a decade ago and strengthen our economy. In doing so, however, the Fed has only kindled speculation from investors who are desperate for large returns and as a result, are willing to pay a higher price for riskier assets. In the stock market, stocks, on average, are overpriced by 65% and nonfinancial companies are overpriced by 57%. Low interest rates are also making it hard for investors to realize their desired level of returns. Furthermore, investors are bidding up junk bonds and collateralized debt obligations composed of risky and subprime loans. The housing market is expanding, and there are similar concerns as five years ago about the dangers of easy credit and faulty appraisals. As a result, the prices of homes are climbing.
Rising housing prices circle back to the actions by the Fed, a cycle that sounds all too familiar of the credit crisis that led to the 2008 recession. The Fed is engaged in what Daniel Alpert, managing partner of Westwood Capital, an investment bank, calls “trickle-down monetary policy” where the benefits of its policies “trickle” down from the wealthy first and then to the rest of the social hierarchy.
The timespan of this potential bubble, however, is only 6 months. Since the end of 2012, the housing market has been increasingly tight. Housing rates, as expected, are great for consumers, but housing inventory is bottoming out. The listed inventory is down 22.5% from last year, the lowest it has been since 2005. There is even a rise in the shortage of luxury homes. In November of 2012, sales of homes worth over a million dollars rose by 51% as more wealthy owners listed their existing homes onto the market and bought new, more expensive ones to avoid the capital-gains tax hike that was implemented earlier this year. Even though construction is increasing as well with an enormous 27% increase from last year, housing prices are increasing at a much faster rate. Loans, as a result, are getting pricier.
However, for the foreseeable future, if homebuyers see a desirable property they should take that first-mover advantage before someone else does. To ensure that these potential homebuyers are responsible consumers, the government has implemented several policies such as The Ability to Repay rule, which will take place later this year. Formed by the Consumer Financial Protection Bureau, this act protects consumers from risky and unethical practices such as “no documentation” and “interest free plans” that were major drivers of the lending of subprime mortgages during the years leading up to 2008. More importantly, this rule protects the consumer from him or herself, an important intervention tactic that will certainly slow down any potential housing bubble. Nevertheless, the Fed is arguably the most critical influence to the economy and needs to be aware of the effects of its policies in the long-run.
Sources:http://www.washingtonpost.com/politics/fed-survey-us-economy-grew-at-moderate-pace-in-spring-led-by-housing-and-autos/2013/04/17/edc26a4e-a788-11e2-9e1c-bb0fb0c2edd9_story.htmlhttp://dealbook.nytimes.com/2013/04/17/efforts-to-revive-the-economy-lead-to-worries-of-a-bubble/?ref=businesshttp://www.forbes.com/sites/realspin/2011/08/25/why-the-monetary-stimulus-didnt-work/2/http://www.federalreserve.gov/pubs/feds/2012/201237/201237pap.pdfhttp://www.nahb.org/reference_list.aspx?sectionID=187