Investment Contrarians

What Else Is Holding the Housing Market Back

By for Investment Contrarians |

What Else Is Holding the Housing Market BackThe crash in the housing market was a devastating hit to the U.S. economy, as millions of people were affected, wiping out massive amounts of wealth. This is why the recovery in the housing market is extremely important. The Federal Reserve has since stepped in and offered unprecedented monetary policy action to try and stem the decline.

While we can argue about whether or not this is an appropriate action, we can’t argue against the fact that the housing market has definitely begun its slow climb back up. A recent report by the S&P/Case-Shiller Home Prices index for 20 cities showed that home prices increased in August by two percent year-over-year, which represents the largest increase in two years. (Source: “Home Prices in 20 U.S. Cities Rise by Most in Two Years: Economy,” Businessweek, October 30, 2012.)

However, while the effort by the Federal Reserve has indeed created some upward momentum in the housing market, there are still many impediments to overcome before we see even more price appreciation.

In a recent report by a Federal Reserve survey, while mortgage applications are rising, 90% of banks stated that for prime or low-risk mortgages, they were maintaining their tight lending standards. (Source: “Banks See Mortgage Requests Rising,” The Wall Street Journal, October 31, 2012.)

According to the data, there is a significant rise in demand for home mortgages over the last several months. However, banks are maintaining extremely tight lending standards, which could be preventing even higher price levels for the housing market.

The banks that are very active in the housing market are leery of overexposing themselves. While I can understand this thinking, considering how little time has passed since the last housing market crash, generally speaking, one should be buying when prices are down and not when they’re at a peak.

While the Federal Reserve has created an environment of lower interest rates to help entice buyers, banks are struggling with the recent memory of the housing market crash. In one way, having tighter lending standards is not a bad thing. The reason we got into this housing market crash was that banks were offering too much money to unqualified buyers.

One of the problems with the Federal Reserve policy is that this might offer a misallocation of capital. By artificially lowering interest rates, they are enticing some buyers who normally wouldn’t be able to afford making a large purchase to take this type of action. I believe that following any kind of crash, whether it is the housing market or any other asset class, it takes time for the market to balance itself out. The Federal Reserve’s action in artificially lowering rates to speed up the recovery process in the housing market might end up causing far greater problems down the road.

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