Recent developments suggest that financial reflation has impacted more than just the stock market. The housing market, after suffering a significant collapse and experiencing years of extraordinary monetary measures, is expanding once more at a concerning pace. Could the Federal Reserve be successfully creating a new housing bubble?
We might not have clarity for years to come. However, there is an unmistakable hint of something amiss in the air. When we take a moment to reflect, can you sense it too?
According to Bloomberg, “The S&P/Case-Shiller index of property prices in 20 cities surged by 13.7 percent from November 2012, marking the largest annual increase since February 2006, following a 13.6 percent rise in the year ending in October.”
“All 20 cities in the index reported year-over-year gains, with Las Vegas leading at an impressive 27.3 percent increase. San Francisco followed closely with a 23.2 percent rise.”
This is great news for homeowners, as the value of their investments is expanding rapidly. Just by living in their homes, they are witnessing significant growth in their wealth. Furthermore, experts suggest this trend could provide an additional boost to the overall economy.
The Impacts of Low-Interest Rates
“Rising home prices are beneficial for consumer spending, as they contribute to increased household net worth. Economists from Bank of America, led by Ethan Harris, have estimated that between 1980 and the third quarter of 2013, every dollar gained in housing wealth contributed to 9 cents in consumer spending, in contrast to only 5 cents for each additional dollar in financial asset wealth.”
In comparison to the 13.7 percent increase in the Case-Shiller index, consumer prices—reflected in the consumer price index—rose by a mere 1.2 percent during the 12-month period ending in November 2013. What could possibly cause housing prices to increase 11.4 times more rapidly than consumer prices?
Recall the arguments made during the peak of the housing bubble: “They’re not making more land.” “Housing prices always rise.”
Perhaps the rapid increase in housing prices compared to other costs can be attributed to the fact that they fell so dramatically and are now recovering. Although the exact cause remains uncertain, it’s likely that inexpensive credit and the accommodating policies of the Federal Reserve play a significant role.
Nevertheless, it doesn’t appear as though housing prices will decline again in the near future. At least not until credit conditions change or a wave of retiring baby boomers seeking to downsize enters the market. We will continue to monitor the situation closely.
The Pitfalls of a Bubble Economy
The key takeaway is that the reflation phase of a bubble economy feels pleasant for many. It creates a sense of security and optimism about personal circumstances and the general economic trajectory. The state of political leadership or the contentious issues surrounding initiatives like MyRA fade into the background when property values are soaring at double-digit rates.
However, the other side of a bubble economy—deflation—can be harsh. As a reminder, January marked a tumultuous shift, demonstrating that bubbles eventually both inflate and deflate. After a year of growth, stocks are now experiencing a downturn.
Following the final Federal Open Market Committee (FOMC) meeting led by Chairman Ben Bernanke, stocks took a hit. “As anticipated,” the International Business Times reported, “the U.S. Federal Reserve on Wednesday voted unanimously to reduce asset purchases by another $10 billion a month beginning February 1, bringing the total down to $65 billion. This reduction was evenly divided, with Treasury purchases cut to $35 billion and mortgage-backed securities trimmed to $30 billion.”
In the wake of the announcement, the DOW plummeted by 189 points. Although stocks rebounded slightly, the DOW remains 4.3 percent lower year-to-date. Based on our rough estimates, the DOW could decline by an additional 15 percent or more.
Yet, we cannot predict with certainty. The ongoing bull market may merely be taking a momentary pause before stocks surge to new heights. Alternatively, we may be witnessing the onset of a downturn in the bubble economy.
As Janet Yellen steps into her new role as Fed Chair today, we watch closely. If stocks decline sharply, she may feel pressured to take drastic measures, such as inflating the monetary supply, to counteract the situation.
Sincerely,
MN Gordon
for Economic Prism
Return from The Downside of the Bubble Economy to Economic Prism
