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Jim Scott
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The Four Percent Solution

The turmoil in the financial markets these past months altered San Diego’s housing market as the era of insanely cheap money is over, replaced by a period of incredibly cheap money. This came about when Mr. Ben Bernanke, the chair of the Fed, stampeded the Wall Street herd in May when he hinted at ending the Fed’s bond-buying program, popularly known as Quantitative Easing (QE). Financial markets overreacted and went into cardiac arrest. Bond prices got trampled as investors rushed the exits. Yields increased one full percentage point and mortgage rates soon followed. None of this should have surprised the Masters of the Universe in Lower Manhattan. QE had done its job and saved housing and everyone knew it had to wind down at some point.

Home buyers temporarily left the marketplace following the sell-off on Wall Street. Resales of existing and new homes in June were lower than in previous months as buyer were spooked by collapsing stock prices and spiking mortgage rates. Not wanting to throw away QE’s hard-won accomplishments, Mr. Bernanke did a quick-step to the side and parsed his earlier incendiary remarks, calming the financial markets. Ten-year treasuries yields (the key benchmark bond that sets the price of home loans) have since come down a little from their peak in early July and will soon settle into a new normal range, probably in the low-to-mid-twos.

Once order was restored on the Street, buyers started looking at homes and writing offers. Buyers worried about higher rates in the future, but at the same time realized the new price of home loans iwas remarkably cheap. Even though they returned to the house hunt, reduced Federal subsidies (artificially cheap mortgages) for house payments had an immediate effect on attitudes, reducing seller’s appreciation expectations. Fear and greed still rule the animal spirits in us all.

Prices are stabilizing in spite of low inventories of homes for sale. Mr. Bernanke has acted to protect buyers from themselves and has served notice that he will not enable another housing bubble. QE has thus far been his weapon of choice by either jawboning, as he did in May, or by changing the amount of the Fed’s future monthly bond purchases. With QE, he can manipulate the price of long term mortgage money and I suspect the Chair was not entirely unhappy with the one-point increase in mortgage rates. He wants just a little inflation in housing prices, not a new bubble. His goal is sustainable inflation in residential values which in turn protects the nation’s banks.

The events of the past sixty days also illustrates the limits of the Fed’s reach. Mortgage rates will slide a little off of their recent highs in the short term, but higher rates are here to stay. My guess is tmembers  of the Fed Board think housing is ready to stand on its own, even considering higher mortgage costs in 2014 and 2015. You should pay attention to those people running hedge funds and other investment pools who are quietly dumping bonds, anticipating higher yields going forward.  

Fortunately the local real estate market has adapted to the higher cost of money. Limited inventories of homes for sale will not necessarily translate into runaway prices. The reduction of federal house payment subsidies, either through the gradual unwinding of QE purchases or ithrough a change in the mortgage interest deduction, will suppress future price increases even in markets with little supply. There will be sporadic instances of buyer indiscretion, but in general there will be fewer dollars chasing the available supply of real estate. Sustainable housing and rent inflation is the goal of the Fed.

The median home price in San Diego is the highest it has been since the dark days of 2008, but it is still far below mid-decade market peaks. It is remarkable that the fallout from the recession has not been worse. Only the bold action of the Fed saved us from a deflationary cycle that could have lasted decades. By tempting the inflation gods, the Federal Reserve Board preventing ruinous real estate deflation. The Fed has also served notice that it can, and will, manipulate long term rates, a radical departure from its traditional role of determining short term rates and the supply of money.

The result of this artful dodging is San Diego’s housing markets are stabilized. Interest rate increases have not derailed demand, but only tempered it.  That in itself speaks volumes about the general health of the market. In the long run, the local citizenry does best without the roller-coaster cycles of housing prices. Bubbles can be exciting in the short term and while certain people make insane profits, in the end the hangover is very costly for the common weal. Even if home loan rates move above five percent over the next 12 to 18 months, that alone will not disturb our overall market stability.

  

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