Fed Aiming at Soaring Asset Values--A Follow-up
Market Views of Comstock Partners, Inc.
Thursday, June 23, 2005
Our commentary last week that the Fed and other regulators were increasingly concerned with the negative potential of soaring house prices was confirmed by a couple of reports released after we wrote. According to the FDIC the 22 major local markets with the fastest growing prices account for 35% of the nation’s housing values. Richard Brown, chief economist of the FDIC stated that, “It’s a widespread boom and has macro implications. A slowdown would not only hurt these markets, but the U.S. as a whole.” The FDIC considers a local market to be experiencing a boom if it has appreciated 30% or more adjusted for inflation, in the past three years. In 2004, 55 of 362 markets qualified, and account for about 40% of national residential values. These findings contradict the opinions of more bullish observers who believe that the boom is strictly local and has little effect nationally.
A second report, this one from Fannie Mae, concluded that the probability of regional housing busts has “risen sharply in certain parts of the country.” It found that conditions in these areas “mirror past conditions that preceded regional housing busts.” These include large increases in the number of riskier loans, interest-only loans, or loans not backed by documentation of the borrower’s income and assets. They found that about 24% of the sub-prime loans included in private label securities were adjustable rate mortgages with an interest-only payment provision. More than 30% of sub-prime loans were topped with a home-equity loan granted at the same time. Overall, mortgage borrowings rose to an average of 91% of home values.
In our view a housing bubble with national implications definitely exists, and the risks to the economy are enormous. The Fed and other depositories are acutely aware of the situation leaving them with the dilemma of what to do about it. If they tighten enough to really halt the rapid rise in home prices the economy could very well go into a nosedive, a particularly scary situation, considering that all the debt still remains on the books. On the other hand if they do little or nothing, the boom could get even further out of hand, making the eventual economic and financial unraveling even worse. So far the Fed is raising the fed funds rate at the so-called “measured pace”, and, along with other agencies, recently started a policy of moral suasion. If this doesn’t work the question is whether the Fed will follow through with more actual tightening. If Paul Volcker was still heading the Fed we would know the answer, but given Greenspan’s consistent reluctance to pull away the “punchbowl” we just don’t know. Either way the outcome is likely to be extremely unpleasant for the economy and for stocks.
© 2005 Comstock Partners, Inc.
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