Is The Value Of Your Home Going To Fall As Rates Rise? 6
Let’s conclude our discussion on mortgage rates, house prices and epiphenomena with the Fed’s role in the housing market.
By extension, the Fed doesn’t really have that much control over the US housing market, at least not through the interest rate channel.
That being said, the Fed does (or did) exert influence on the US housing market through their purchase of Mortgage Backed Securities (MBS).
While the Fed has called time on making new net additional purchases as it begins to tighten monetary policy, it is still reinvesting principal payments on previous MBS purchases.
This has led many to believe that the Fed is still acting to artificially keep mortgage rates low, thereby contributing to higher housing prices.
While this sounds logical and seductively simple, it isn’t true.
Firstly, most people believe that the Fed’s MBS purchases gives banks carte blanche to make as many new mortgages as possible. This is not the case, as banks must make mortgages in accordance with GSE (Fannie, Freddie, etc) requirements in order to sell them to the GSEs.
The Fed can’t, or rather, won’t, purchase them otherwise.
As such, the Fed does have some influence in that particular subset of the market (GSE mortgages), but not outside of it.
The real driver of the US housing market is total bank mortgage lending, as detailed in our article on QE’s effect on housing.
Bank mortgage lending is in turn determined by two main forces.
First is of course the bank’s willingness and ability to originate new housing loans, and second, the demand for such loans from potential home buyers.
The interaction of these two forces is what truly matters, not the Fed.
Furthermore, we know that the “low rates = high house prices” line of thinking is empirically untrue. This is easily observed, yet somehow missed by mainstream commentators, in the current environment where house prices and mortgage rates have been rising together.
If the Fed’s MBS purchases really did keep rates low, wouldn’t mortgage rates continue to be low even as house prices skyrocketed?
Ultimately, misunderstanding, or grossly overestimating, the Fed’s role in the housing market stems from two different but interconnected sources.
The first is a Fed-centric paradigm, where the Fed is mistakenly perceived as sitting in the center of the financial system, and therefore thought to be omnipotent. (Spoiler alert: The Fed isn’t the center of the financial universe, and it isn’t omni-anything)
The second is a conflation of epiphenomena; the direction of interest rates and house prices, which turns out to be nothing more than a more specific instance of the interest rate fallacy.
Finally, it is important to note that real estate prices are a famously local phenomenon, hence the adage “location, location, location”.
The purpose of this series of articles is to demonstrate the relationship between rates and home values from a broad macro standpoint, hence our use of the National home price index in earlier parts.
If national home prices do fall, it will be for a combination of factors. Chief of which being demand falling due to buyers facing economic uncertainty, or an oversupply of housing, perhaps even a mixture of both.
Mortgage/interest rates will certainly play a part as the cost of financing, but in all likelihood they won’t be the major cause.
If you ever find yourself getting caught up in mainstream narratives conflating rates with house prices, remember Fat Tony words!
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