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Housing prices have risen dramatically not because of simple supply and demand, but because the Fed literally created demand by making the cost of borrowing money artificially cheap” Ron Paul 2007

The real estate market as measured by price increase (not volume of sales) is recovering. This recovery is mainly attributable to low interest rates engineered by the Federal Reserve’s quantitative easing (money printing) policies combined with low for sale inventory.

In “Student Loans and Unemployment are Holding Back the Economy and Real Estate Market” I noted the reasons for low inventory:

-the foreclosure rate has been dropping and fewer distressed properties are being put on the market (although there are signs that this trend may be reversing);

-many home owners are still underwater from the last real estate bust and can’t sell;

-still other home owners who have positive equity in their homes are viewing the recent uptick in home prices as a sign that prices will continue to rise and are holding back on listing their homes hoping for higher prices; and

-new home starts in the past five years are well below their historic average

A new survey from Fannie Mae shows that 40% of homeowners think now is a good time to sell up from 16% a year ago.

Just as more home owners start thinking its a good time to sell:

more home owners are reemerging from underwater mortgages;

homebuilders are increasing production; and

banks are increasing foreclosure activity

with the combined potential to increase significantly the amount of inventory, the Fed starts making noises that it may “taper” its bond buying program which has held interest rates low. A “tapering” from $85 billion a month of Mortgage Back Securities and U.S. Treasuries to $65 billion would still be a highly accomodative $780 billion a year program! See Chart.

The immediate reaction to the Fed’s taper talk has been a spike in interest rates.

While the Fed’s QE program may have ignited the real estate (and stock) market(s) with low interest rates in a market with tight inventory, it has been ineffective in stimulating the rest of the economy and the job market.

While more homes come on the market, higher interest rates may deter buyers creating a reversal from shortage to glut. Indeed, inventories are already starting to rise.

Further pressuring demand:

the stubbornly low labor participation rate that remains at a 32 year low;

average weekly hours falling to 34.5 hours suggesting underemployment among those employed;and

a strong pipe line of new home buyers is failing to materialize as millennials suffer from under employment, higher unemployment rates and crushing student loan debt (also caused by easy money policies).

Thus, the Fed’s “No Exit” Dilemma -they have heated up the market with their Abracadabra QE experiment, but they can’t cool it down because to do so would cause a sudden reversal in the housing and stock markets.

The Fed may have created a brief shining moment in the real estate and stock markets before the crash. But don’t worry, there will be many more such moments as the Fed’s reaction to any crash is to print more money to try to reheat the economic souffle.

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