February home sales activity resulted in the 59th consecutive, month-over-month gain for Twin Cities and U.S. home prices (when measured on a 1-year moving average), making this one of the longest-lasting bull markets for housing in U.S. history.
Why are home prices rising so fast? I believe that if we want to understand the root cause of the abnormal and extreme volatility that we have experienced in housing over the past two decades (including the boom and bust cycle that occurred from 2001 through 2011 and the current cycle that began in 2012), that we have to look more in-depth at the Federal Reserve's unprecedented experimentation with the manipulation of interest rates, inflation of the money supply (including where the newly created money has been directed) and the moral hazards caused by government-sponsored entities, Fannie Mae and Freddie Mac.
Federal Reserve - Central Inflation of the Money Supply: When discussing the current housing boom, many economists brush aside or ignore the fact that more than $1 trillion of the $3.5 trillion in QE (Quantitative Easing) funds that the U.S. Federal Reserve created from 2009 to 2014 (to "stimulate the economy" beyond the effects of 0% interest rates) were used to directly subsidize Fannie Mae and Freddie Mac, America's two primary mortgage lenders by purchasing their mortgage-backed securities.
Federal Reserve - Central Manipulation of Interest Rates: Most economists agree that at least some level of fault for the housing crisis of 2007 falls on Alan Greenspan for keeping interest rates "too low for too long" in the recession that followed 9/11/2001. If by lowering the Fed Funds Rate from 6% down to 1% in 2001 and keeping it there through 2004, Alan Greenspan's Federal Reserve helped to inflate a housing bubble, then what will be the result of the Federal Reserve's extended decisions to reduce the Fed funds rate to 0% (Zero Interest Rate Policy) in 2008 and keep it there indefinitely (so far, for 8 years and still counting)?
Fannie Mae & Freddie Mac - Central Manipulation of Lending Standards: Because Fannie Mae and Freddie Mac are government-sponsored entities there is an implied bailout which means capitalized profits but socialized losses. This is not free market capitalism, it's crony capitalism but more importantly, it creates a massive moral hazard distorting the marketplace. The incentive to gamble for profits is high while the incentive to protect the company and its shareholders from catastrophic losses is significantly minimized. Additionally, (as mentioned above) since QE began in the U.S. in 2009, Fannie Mae and Freddie Mac have received over $1 trillion from the Federal Reserve's massive inflation of the money supply. Since 2009, Fannie and Freddie have been quietly but steadily easing their already artificially loose (at least in regards to down payments) lending standards.
Where do we go from here? Many of the economists who accurately predicted the formation and collapse of the last U.S. housing bubble that burst in 2007 are again warning that the Federal Reserve's extreme monetary reaction to the crisis of 2008 and continued manipulation of interest rates are once again causing the unintended consequences of a re-inflated housing bubble. Will the Federal Reserve be able to allow interest rates to return to a normal level and unload their balance sheet without crashing the market?
Related Blog Post: Twin Cities Home Prices: Highest Ever
Supporting Source: Effective Federal Funds Rate
Supporting Source: Fannie Mae and Freddie Mac: Structurally Unsound
Supporting Source: Twin Cities Housing Market Data
Why are home prices rising so fast? I believe that if we want to understand the root cause of the abnormal and extreme volatility that we have experienced in housing over the past two decades (including the boom and bust cycle that occurred from 2001 through 2011 and the current cycle that began in 2012), that we have to look more in-depth at the Federal Reserve's unprecedented experimentation with the manipulation of interest rates, inflation of the money supply (including where the newly created money has been directed) and the moral hazards caused by government-sponsored entities, Fannie Mae and Freddie Mac.
Federal Reserve - Central Inflation of the Money Supply: When discussing the current housing boom, many economists brush aside or ignore the fact that more than $1 trillion of the $3.5 trillion in QE (Quantitative Easing) funds that the U.S. Federal Reserve created from 2009 to 2014 (to "stimulate the economy" beyond the effects of 0% interest rates) were used to directly subsidize Fannie Mae and Freddie Mac, America's two primary mortgage lenders by purchasing their mortgage-backed securities.
Federal Reserve - Central Manipulation of Interest Rates: Most economists agree that at least some level of fault for the housing crisis of 2007 falls on Alan Greenspan for keeping interest rates "too low for too long" in the recession that followed 9/11/2001. If by lowering the Fed Funds Rate from 6% down to 1% in 2001 and keeping it there through 2004, Alan Greenspan's Federal Reserve helped to inflate a housing bubble, then what will be the result of the Federal Reserve's extended decisions to reduce the Fed funds rate to 0% (Zero Interest Rate Policy) in 2008 and keep it there indefinitely (so far, for 8 years and still counting)?
Fannie Mae & Freddie Mac - Central Manipulation of Lending Standards: Because Fannie Mae and Freddie Mac are government-sponsored entities there is an implied bailout which means capitalized profits but socialized losses. This is not free market capitalism, it's crony capitalism but more importantly, it creates a massive moral hazard distorting the marketplace. The incentive to gamble for profits is high while the incentive to protect the company and its shareholders from catastrophic losses is significantly minimized. Additionally, (as mentioned above) since QE began in the U.S. in 2009, Fannie Mae and Freddie Mac have received over $1 trillion from the Federal Reserve's massive inflation of the money supply. Since 2009, Fannie and Freddie have been quietly but steadily easing their already artificially loose (at least in regards to down payments) lending standards.
Where do we go from here? Many of the economists who accurately predicted the formation and collapse of the last U.S. housing bubble that burst in 2007 are again warning that the Federal Reserve's extreme monetary reaction to the crisis of 2008 and continued manipulation of interest rates are once again causing the unintended consequences of a re-inflated housing bubble. Will the Federal Reserve be able to allow interest rates to return to a normal level and unload their balance sheet without crashing the market?
Related Blog Post: Twin Cities Home Prices: Highest Ever
Supporting Source: Effective Federal Funds Rate
Supporting Source: Fannie Mae and Freddie Mac: Structurally Unsound
Supporting Source: Twin Cities Housing Market Data
