Regulations

The dark side of rising home prices

What happened in 2008 could very well happen again

Former Federal Reserve Chairman Ben Bernanke was correct in saying at the time* that there had never been a decline in housing prices on a nationwide basis. What he was oblivious to was that home prices were rising nationwide faster than they ever had because his predecessor, Alan Greenspan, had brought the federal funds rate down to 1 percent. By mid-2007 the housing market party was over and prices began a four-year nationwide decline.

Fast-forward to 2015: The Fed has learned that you can reheat an economic souffle. We are in the midst of another housing bubble driven by Ben Bernanke and Janet Yellen’s fed funds rate at zero percent and massive doses of quantitative easing (QE) that involved the Fed buying $85 billion a month worth of mortgage-backed securities and U.S. Treasury securities.

The dark side

Although the Fed and others cheer on the rise in housing (and stock market) prices as good for homeowners and the economy, there is a dark side to rising home prices.

Rising home prices:

Are artificial

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The current surge in home prices is not driven by strong economic fundamentals such as higher productivity, wages and labor participation rates, but rather by artificially low interest rates orchestrated by the Federal Reserve’s zero interest rate policy and quantitative easing programs.

Bernanke admitted as such when he testified to Congress in July 2013 during his tenure: “I don’t think the Fed can get interest rates up very much, because the economy is weak, inflation rates are low; if we were to tighten policy, the economy would tank.” Interest rates are still at zero, presumably because the economy is not quite ready to stand on its own without artificially low interest rates.

Home prices are artificially rising by Fed design. So, who cares? Higher housing prices, no matter how generated, are a good thing, right?

• Lower housing affordability

Ask a first-time homebuyer, a part-time worker or anyone looking for a home if higher home prices are a good thing. Higher home prices shut would-be homebuyers out of the market, lower the homeownership rate and raise the cost of shelter.

From 2012 to 2014, according to RealtyTrac, U.S. median weekly wages grew just 1.3 percent while U.S. median home prices grew 17.31 percent.

Create wealth disparity

Higher home prices create wealth disparity between homeowners and nonhomeowners. Homeowners get richer merely by occupying homes, while renters don’t obtain the same passive benefits.

Homeowners also gain access to cheap credit not available to renters in the form of low-interest home equity loans. And don’t forget the mortgage interest deduction for homeowners.

• Cause property taxes to rise

Because property taxes are based on home values, rising home prices lead municipalities to increase property taxes. For homeowners whose economic circumstances have not improved other than experiencing an increase in the price of their homes, increased property taxes put an added strain on their finances.

I suppose they can always take out a home equity loan to pay their higher property taxes.

Higher home prices can also lead municipalities to make overly optimistic projections on future tax revenues and to misallocate and/or overspend based on the (perhaps false) prospect of future increased tax revenue.

• Prevent mobility

The whipsaw in housing prices over the past 10 years — dramatically higher, then lower then higher again — creates an immobile workforce whose fortunes and mobility are tied to the values of their homes.

Often homeowners remain in areas where their job prospects are dim because their home equity is underwater from the last housing bubble/bust or can’t move to where they might get a job because housing prices are too expensive in those markets.

An immobile workforce hinders economic recovery that would otherwise take place.

• Are bad for the real estate industry

Although higher home prices lead to higher commissions, Fed-driven home price appreciation also leads to investor speculation in the housing market making it susceptible to booms and busts. During the busts few homes are sold. This leads to a feast-or-famine market for real estate agents that doesn’t allow them a level of predictability of income or investment.

Higher home prices put homeownership further from reach. Young first-time homebuyers already are facing difficulties in purchasing homes as many have large student loan debts and are unemployed or underemployed.

Potential new homeowners whose wages are not keeping pace with rising home prices and millennials find homeownership ever more elusive.

Without a solid pipeline of new homebuyers, the mid- and long-term outlook for the real estate industry is dim.

Will come down

The Fed’s manipulation of the economy by driving rates down to get people to move in and out of houses is as foolish as paying people to dig ditches and then paying others to fill them up. Nothing of lasting structural value is produced in either example.

This artificially manipulated game of real estate musical chairs works until the music stops.

And it will as the low inventory/strong demand dynamic reverses and inventory increases and demand drops.

A housing inventory shortage is not the same as a housing shortage. We have a temporary inventory shortage, not a permanent housing shortage. Inventory will become available just as demand drops due to a weak economy and rising interest rates. When that happens, this housing bubble will burst.

It’s foolish for the Fed to think that housing can drive an economy and to set policy designed to create a housing bubble. The housing market should be reflective of the strength of the economy, not the driver of it.

We saw what happened in 2008 after we had massive nationwide rise in prices and subsequent massive decline.

Still want higher home prices? Be careful what you wish for.

*Ben Bernanke was chairman of President George W. Bush’s Council of Economic Advisers from June 2005 to January 2006 prior to being named as chairman of the Federal Reserve in January 2006.

Louis Cammarosano is the author of Smaulgld, a blog that provides finance, economics and real estate market analysis, and marketing strategies and tips for real estate professionals.

Email Louis Cammarosano.