Can the Fed Save Housing?

Yesterday the market got a lift from the FOMC statement which was interpreted to indicate that the Fed no longer held a tightening bias, setting the stage for a possible rate cut later this year. The expectation is that Fed easing will help the troubled housing sector by making it easier for people who are struggling to meet their mortgage payments to refinance at lower interest rates.

I can’t see how lower interest rates can save the housing market. First, the rise in defaults on subprime mortgages have prompted all the major lenders to tighten lending standards. As this graph shows, the last time lending standards were substantially tightened was in 1990 and 1991, which were terrible years for housing. Despite lower costs for mortgages, tighter lending standards may make getting a mortgage approved more difficult.

Second, inventories are at record levels and may continue to rise due to a large number of homes currently in the foreclosures process. In order for housing activity to recover, the large supply of homes on the market needs to be reduced. Even if lower interest rates were to increase demand, it could take a while for this inventory to be worked down.

And third, stagnant prices over the last year may have shaken investor confidence. Speculators, who were a significant source of demand for homes during the last few years, are not likely to be persuaded by Fed rate cuts to jump back in. More likely, they will wait until there is clear evidence that home prices have recovered before jumping back in with both feet.

The Fed was unable to save the internet/telecom sector in 2001. However, that monetary easing did spark a boom in the housing sector. It is possible that Fed easing will again help fuel a bubble in another sector of the economy. But housing can’t be revived so quickly.

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