The Federal Reserve Board yesterday released the minutes of the May Federal Open Market Committee (FOMC) meeting erasing any doubt that they had initially underestimated the significance of the current housing decline.
From yesterday’s released minutes:
“The incoming data on new home sales and inventories suggested that the ongoing adjustment in the housing market would probably persist for longer than previously anticipated. In particular, the demand for new homes appeared to have weakened further in recent months, and the stock of unsold homes relative to sales had increased sharply.
Nevertheless, most participants agreed that, although the level of inventories of unsold homes that homebuilders desired was uncertain, the correction of the housing sector was likely to continue to weigh heavily on economic activity through most of this year--somewhat longer than previously expected.
Participants remained concerned that the housing market correction could have a more pronounced impact on consumer spending than currently expected, especially if house prices were to decline significantly.
The Committee thought that the statement should reiterate the view that the adjustment in the housing market was ongoing, but that nevertheless the economy seemed likely to expand at a moderate pace over coming quarters.”
It’s important to keep in mind that as recently as the January meeting, the Fed was talking stabilization ala Bob Toll and The National Association of Realtors.
From the January FOMC minutes:
“The decline in residential construction continued to weigh on overall activity, but some indications of stabilization in the demand for homes had emerged.
Residential construction activity remained quite weak late last year, but home sales showed some tentative signs of stabilization.
Inventories of unsold homes remained considerable although they ticked down in December for the second straight month. The most timely indicators of home prices, which are not adjusted for changes in quality or the mix of homes sold, pointed to small declines.
In their discussion of the major sectors of the economy, participants noted that the housing market showed tentative signs of stabilization in most regions.”
Additionally, looking back just one year, it seems obvious now that the Fed initially choose to hold a very optimistic outlook for an obviously speculative and historically overheated housing market.
From the May 2006 FOMC minutes:
“Anecdotal information pointed to some cooling of housing markets.
That cooling was especially noticeable for high-end homes and for houses in markets that previously had experienced the steepest appreciation.
Data on home sales, permits, and starts on the whole likewise suggested that activity was gradually diminishing.
Some reports indicated that speculative building of homes had dropped off considerably, but inventories of unsold homes still seemed to be expanding.
Although fresh comprehensive data were not available, home prices on average appeared still to be rising, but at a slower pace than over the past few years.
Certain features of recently popular nontraditional mortgage products had the potential to cause financial difficulties for some households and erode mortgage loan performance for some lenders.
Nonetheless, the household sector seemed likely to remain in sound financial condition overall.
On balance, consumption spending was viewed as most likely to expand at a moderate pace in coming quarters.”
Paradoxically, the latest sentiment caused Wall Street to rally apparently on the notion that the Fed is “out of the way” in terms of interest rate hikes and soon may even lower rates in an effort to soften the blow of the housing decline.
It’s important to keep in mind that the leadership at the Fed has, on several occasions, outlined very clearly that they do not intend on stepping in to preserve specific asset prices particularly homeowner equity.
The following excerpt was taken from a speech given by Federal Reserve Governor Donald L. Kohn in March of 2006 titled “Monetary Policy and Asset Prices“.
“Conventional policy as practiced by the Federal Reserve has not insulated investors from downside risk. Whatever might have once been thought about the existence of a "Greenspan put," stock market investors could not have endured the experience of the last five years in the United States and concluded that they were hedged on the downside by asymmetric monetary policy.”
“The same considerations [as was given to dot-com stock holders] apply to homeowners: All else being equal, interest rates are higher now than they would be were real estate valuations less lofty; and if real estate prices begin to erode, homeowners should not expect to see all the gains of recent years preserved by monetary policy actions. Our actions will continue to be keyed to macroeconomic stability, not the stability of asset prices themselves.”
