SAN FRANCISCO — The financial crisis is over and the economy is growing at a fast enough clip that the Federal Reserve and other policymakers have already fallen behind the curve in preventing the next asset bubble, economist Ken Rosen said today.
Rosen, the chairman of the University of California, Berkeley’s Fisher Center for Real Estate, acknowledged that most economists are still more worried about deflation than inflation.
In an hour-long presentation as the keynote speaker at the Fisher Center’s 15th annual real estate conference, Rosen clicked through a stack of statistics and forecasts to make his case that it’s time for the Fed to raise short-term interest rates.
"The financial crisis is over," Rosen said, but the Fed appears to be committed to keeping short-term rates at or near zero for at least six months. "I think short-term rates should be 2 to 3 percent today — we are encouraging asset bubbles in the stock market, bond markets and global real estate."
While emergency measures taken by the government to head off a collapse of the financial system were warranted, Rosen said, there’s been "a very big bounce off the bottom," and the low cost of borrowing is encouraging risk-taking.
Rosen predicts inflation could quickly rise to 3 to 5 percent, forcing the Fed to play catch up and raise short-term interest rates to between 3 and 4 percent within two years. The delay in raising short-term rates is "a huge mistake in monetary policy — the same mistake we made in the last cycle," he said.
Rosen sees only a 10 percent chance of an L-shaped recovery in which the economy slips back into a mild recession, but a 35 percent chance of a U-shaped rebound with 3.5 percent growth. The most likely scenario is a W-shaped recovery, with further ups and downs, he said.
Rosen is projecting 2.2 percent economic growth this year, with unemployment falling to 9.8 percent. By 2012, he expects "more sustainable" 3 percent growth and 8.1 percent unemployment — along with higher interest rates, inflation, and taxes.
"Exploding" federal and state budget deficits and unfunded liabilities are "shocking," he said, and are likely to lead not only to spending cuts but tax increases.
While it typically takes up to two years for the economy to start adding jobs after a recession, employers cut so deeply they can’t provide the minimum level of services and will bring 1 million workers back on their payrolls this year, Rosen predicted.
To the average person on the street, the recovery may seem weak, Rosen acknowledged. It will take three to four years to replace the 8.4 million jobs lost during the recession, he predicted.
But global demand is already putting pressure on commodities prices, and China is in the midst of a speculative real estate bubble of its own, he said.
The outlook for U.S. housing is promising — falling prices and low mortgage rates have produced dramatic improvements in affordability in many markets, and household formation is likely to drive demand for homes.
But with the Federal Reserve winding up its ongoing purchases of $1.25 trillion in mortgage-backed securities last month, mortgage rates are expected to go up.
If mortgage rates stay in the 5 to 6 percent range, that will help keep housing affordable, "but if we go to 7 or 8 percent quickly, that won’t be good," Rosen said.
While there’s been no dramatic increase in the "spread" between mortgage-backed securities and Treasurys, "that’s the big worry — can we keep rates low?"
Demand for housing should pick up as employers hire more workers, with immigration and demographic trends also significant drivers, Rosen said.
Many unemployed workers who moved back in with their parents or are living in apartments with roommates will strike out on their own again once they find jobs.
There’s a huge wave of "echo boomers" — children of baby boomers — coming into the workforce in coming years, he noted, and immigration in this decade is expected to outpace the last.
Re-regulation of mortgage securitizations will promote conservative, sensible underwriting, Rosen predicted, meaning homeownership is unlikely to rebound to its peak of 69 percent during the boom — settling in at something closer to 66 percent, he said.
On the supply side of the equation, Rosen expects new housing production will remain below the historical norm of 1.1 million homes a year, and will take two to three years to bounce back. But he expects foreclosures to set new records in 2010 and for problems to drag into 2011.
"The shadow inventory is real," Rosen said, and the threat is not only from foreclosures (see Inman News article: "Fears of an REO glut persist").
There’s also the issue of pent-up supply — homeowners who are waiting for prices to stabilize before putting their homes on the market.
In the short term, the looming expiration of the homebuyer tax credit will also produce "some weakness in the second half of the year" by pushing demand forward, Rosen said.
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