Econ 101 says lower interest rates are good for the housing market. But the chief economist of the National Association of Realtors, Lawrence Yun, worries there could be too much of a good thing. In a recent visit to BusinessWeek (see video), Yun said he fears that if the Federal Reserve cuts rates too much more, it will stir fears of inflation, which will push up rates on 30-year fixed-rate mortgages. Lenders will charge more for loans to make up for the higher inflation they expect. Higher rates on 30-year mortgages would be another blow to the reeling housing market.
A few thoughts on Yun’s theory:
1. At this point, the main reason the Federal Reserve is cutting short-term interest rates aggressively is to save the financial system, not so much housing in particular.
2. Inflation is uncomfortably high right now, but it’s likely to come down if the economy continues to soften, because there’s less pressure on wages and prices of goods and services when recession curtails demand. Lower inflation expectations would help mortgage rates fall.
3. While the Fed’s rate cuts have an ambiguous effect on long-term rates, they are definitely helping lower short-term rates, which is good for the many people who have adjustable-rate mortgages. According to a report released today by Standard & Poor’s RatingsDirect:
“According to our analysis, as of March 18, 2008, the decline in six-month LIBOR from a 52-week peak of 5.6% has reduced subprime payment schock on the average two-year fixed-rate hybrid loan by as much as 95%, has virtually eliminated Alt-A payment shock, and has made the post-reset payments easier for all borrowers to handle.”