Low Interest Rates Could Create New Housing Bubble

April 11, 2013

One of the primary causes of the housing crisis that erupted in 2007 was poor lending standards that allowed unqualified people to qualify for loans they should never have had in the first place. Six years later, the Federal Reserve might be creating a new housing bubble through its efforts to stimulate the economy and promote recovery. By keeping interest rates artificially low, the Fed might be creating a new housing bubble that is not based on actual wage growth or demand, says Edward Pinto, a resident fellow at the American Enterprise Institute.

  • Along with stock market highs and record bond prices, housing prices jumped more than 8 percent over the last year -- the biggest annual gain since 2006.
  • The rising housing prices have added $1 trillion to the market value of single-family homes, which theoretically raises consumption because consumers now have more wealth.
  • Recent Federal Housing Finance Agency (FHFA) data suggests that the increase in house prices is not due to increased demand, wages and an improved economy, but rather the rising market value of homes is due solely to the Fed's lower interest rates.

What seems like a housing recovery is actually the result of the government's recent efforts to guarantee almost 90 percent of new mortgage debt.

  • The government has financed half of all home mortgages to buyers with zero equity at closing while encouraging the Fed to buy great quantities of new mortgage debt.
  • New and existing home buyers purchased 9 percent and 15 percent more, respectively, in February of 2013 than one year previous.
  • Lower interest rates for these buyers mean that the monthly finance cost to purchase a new home remained roughly the same over the last year.

Wages have only risen 2 percent over the last year, signifying that federal policies to support the housing industry might be setting the country up for another bursting bubble.

  • Interest rates cannot stay low forever and eventually the Federal Reserve will have to raise rates.
  • To sustain an increase to a 6 percent average mortgage rate, incomes would need to increase by 33 percent, house prices would need to decline by 25 percent or lending standards would need to be loosened to keep houses as affordable as today.

Source: Edward Pinto, "Is the Fed Blowing a New Housing Bubble?" Wall Street Journal, April 9, 2013.

 

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