Housing Slump Has Broad Ramifications According to Chairman Bernake

Fed chief sees housing as a risk

By Patrice Hill
THE WASHINGTON TIMES
November 29, 2006

 

Federal Reserve Chairman Ben S. Bernanke said yesterday that a deepening housing slump is the biggest risk looming over the economy, a warning driven home by an industry announcement of the biggest drop in the nation’s median home price on record.
That median price drop of 3.5 percent was recorded by the National Association of Realtors and was led by a 5 percent drop in the Northeast. Futures markets are predicting further drops totaling more than 8 percent on average in the Washington area, Miami, Chicago, Los Angeles and other major cities by the middle of next year.
“The correction in the housing market could turn out to be more severe and widespread than seems most likely at present,” Mr. Bernanke said in a speech to the National Italian American Foundation in New York.
A downturn in prices was “inevitable” after the extraordinary run-up between 2000 and 2005 that raised prices nationally by 60 percent and doubled or tripled home values in Washington and other hot markets on the East and West coasts, he said.
House prices went so high in many areas that they became unaffordable for average buyers, he said, and that “sowed the seeds of the correction” now under way by limiting demand for homes and forcing the need for price cuts and incentives to bring purchasers back into the market.
He suggested the rise in interest rates engineered by the Fed since 2004 was a less important factor precipitating the housing downturn.
While the deceleration in home prices and the housing-led slowdown in the economy so far this year has been welcome among central bankers intent on cooling the fires of inflation, Mr. Bernanke said, further deterioration could threaten the already low 1.6 percent pace of economic growth by undermining consumer confidence and spending, which had gotten a big boost during the housing boom.
“A deeper correction would directly affect economic activity through additional cutbacks in housing starts and through its effects on employment in construction and housing-related industries. More indirectly, it might also impose greater restraint on consumer spending by reducing homeowners’ equity and thus household wealth, and perhaps by affecting consumer confidence.
“Because consumption makes up more than two-thirds of aggregate expenditure, any significant effect on consumer spending arising from further weakness in housing would have important implications for the economy,” he said, although “to date there is little evidence that the weakness in housing markets is spilling over more broadly to consumer spending or aggregate employment.”
Mr. Bernanke took heart that home sales appear to be stabilizing, with the Realtors reporting a slight increase of 0.5 percent in existing-home sales last month, the first in eight months. Big price cuts and incentives also brought about increases in new-home sales during August and September.
But the number of homes on the market for sale keeps rising, and at today’s slow sales pace, will take a long time for the market to absorb, Mr. Bernanke noted. The inventory overhang also will force developers to cut building plans by even more than the 35 percent slash in construction starts they already have ordered this year, and thus will continue to weigh on growth well into next year, he said.
Dramatic cuts in auto production also have been depressing growth, the Fed chairman said, but “outside of the housing and motor vehicle sectors, economic activity has, on balance, been expanding at a solid pace.”
Mr. Bernanke said the Fed continues to be “uncomfortable” with the underlying rate of inflation running at 2.4 percent to 2.7 percent — well above the Fed’s unofficial target range of 1 percent to 2 percent. He blamed higher costs for energy and other raw materials, which are being passed on by businesses, as well as a jump in housing inflation to 4 percent from 2.25 percent last year.
The government’s measure of housing inflation reflects the cost of renting single-family homes rather than the direct costs of owning homes, such as mortgage payments, insurance and taxes — a feature that some economists criticize.
The design of the index has created a statistical enigma: Measured housing inflation has been going up even though home prices are dropping, while it was flat during the years home prices were soaring.
The reported rise in housing inflation “may reflect in part a shift in demand toward rental housing as families judged homeownership to have become less financially attractive of late,” Mr. Bernanke said, but his remarks suggested the Fed is unsure about the reliability of the housing measure.

http://washingtontimes.com/business/20061128-093710-8201r.htm

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