The Fed Takes Action; and Why it Probaly Won’t Affect Your Real Estate Transaction

September 19, 2007 |

ratecut.jpgRemember my post from yesterday about Ben Bernanke and Judo Economics? Today, we got to see the plan in action as the Fed announced a 1/2-point reduction in the federal funds rate. Wall Street rejoiced. You can read the announcement from the Fed here. For additional coverage, check out USAToday and my personal favorite, Financial Times.

While the cut in short-term interest rates is significant, historic relative to recent Fed actions, what does it mean for the real estate market? Not much. Sure, there is a psychological effect on the market, but the real effect on the real estate market will probably be negligible, if at all. Consider what Financial Times wrote about the cut:

To the extent that they are able to reduce the recession risk, their actions should help stabilise financial markets, in particular the market for mortgage-backed securities.

Some of the most senior officials favoured a 50bp [basis point] move to create a positive psychological effect on the markets.

Notice that the quote mentions stabilization in “financial markets” and “mortgage-backed securities” in particular. For those of you who are thinking, “that’s good. That means mortgage rates will be lower.” Not necessarily the case. What the Financial Times article is talking about is the secondary mortgage market, and reducing volatility for investors who are seeking to invest in mortgages, not changing things for people applying for mortgages.

For further evidence, look to the USAToday article:

A cut from the Fed should “help alleviate some of the tensions in financial markets and provide a boost to consumers and homeowners currently feeling the pressure of relatively tight lending conditions,” Ruesch International said in a note to clients Tuesday morning. What it means:

• Banks were expected to immediately cut the prime rate, base rate for many business and consumer loans, such as home equity lines of credit and credit cards, from 8.25% to 7.75%.

• Rates on adjustable-rate mortgages may fall, although many are based on other interest rates. The Fed has even less control over fixed mortgage rates, which are tied to 10-year Treasury yields. Those have fallen in recent weeks as investors flocked to the safer investments. Bond yields fall as prices rise.

The average rate for a 30-year, fixed-rate mortgage was 6.31% last week, down from 6.46% the previous week and 6.43% a year ago, according to Freddie Mac.

Notice that mortgage rates are not directly tied to the Fed funds rate. The 1/2-point reduction may have a trickle-down effect on mortgages, but there probably won’t be significant jump in mortgage applications just because the funds rate dropped. Mortagage rates are already quite low, lower even than the same time a year ago. Expecting them to go significantly lower is unreasonable.

If your home is on the market right now, and you were hoping that the Fed was going to do something to change the real estate market, your hope was misplaced. Buyers aren’t going to come flooding into the market now that short-term rates have dropped; and prices aren’t suddenly going to go up in areas where they have been receding. But then again, the Fed knows this. As I said yesterday, Ben Bernanke’s job is not to correct the real estate market, it is to monitor the entire economy. The Fed said just that in its press release today:

Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

The only mention of the real estate market is a possible intensification in the “housing correction.” Notice, however, that there is no mention of the real estate market when talking about the intended effect of the rate reduction, only mention of the “broader economy.” If you were waiting for Bernanke and the Fed to help sell your house, you are going to be waiting a long time.

There is no magic potion that will cure what ails the real estate market in most areas of the country. The market fundamentals are pretty screwed up in a lot of places. Until prices come down to the point where they meet demand, homes will continue languish on the market. No action that the Fed will take can remedy that situation.

[tags] real estate, realtor, charlottesville, virginia, federal reserve, interest rates, bernanke, wall street [/tags]

 

 

Posted by Daniel | Filed Under Finance, Industry Issues, News, Selling 

Comments

2 Responses to “The Fed Takes Action; and Why it Probaly Won’t Affect Your Real Estate Transaction”

  1. Jeremy Hart on September 20th, 2007 5:32 pm

    Excellent post, Daniel - I’ve had two sellers call in the last couple of days and ask what this is going to mean for their house sale. It’s not an instant shot in the arm and everything is okay, it’s a steady adjustment that will slow the cyclical changes, but won’t eliminate them. Very insightful, good job.

    [Reply]

  2. Daniel Rothamel on September 20th, 2007 6:13 pm

    We have been fielding the same questions from our clients. You are exactly right. Thanks for the comment.

    [Reply]

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