"A fire sale" of US bonds, such as the funds of large universities are carrying out, is liable to cause bond prices to crash and send long-term interest rates soaring. A new crisis in the recovering housing market is then only a matter of time. Mortgage interest rates in the US have been creeping upwards in recent weeks, although the interest rate on 30-year fixed-rate mortgages is still just 3.91%.
The concern is that a jump in the interest rate on long-term loans, such as mortgages, will deliver a serious blow to the fragile US economic recovery. Prof. Stephen D. Oliner, who held a series of senior positions in the US Federal Reserve over 30 years, is an expert on the subject.
"Globes": US home prices are still rising, almost 11% in the 12 months through March. On what basis is the market recovering?
Oliner: "Prices began to rise, especially in areas which were severely affected by the bursting of the bubble, such as California. But the recovery is still in the early stages, and comes after a very sharp drop in market activity as a result of the 2008 crisis. In fact, new construction has not yet returned to a normal level, or even close to it."
There are claims that the recovery is driven by investors, rather than by the general public.
"Investors are now taking a larger share of the housing market, far beyond the normal proportion. They are buying cheaply, renovating, renting, and expect to sell at a higher price later. In my opinion, this is a helpful development, because we have a shortage of rental properties, and this offers a solution for people who cannot really buy a home now in their current financial situation."
Oliner's name appears in the bibliography of a Bank of Israel research report published two weeks ago, in which there appears, for the first time, an index of the change in residential land prices. Surprisingly, the US does not yet have such an official national index of changes in land prices, even though the value of land was $17 trillion in 2006.
"This is a noteworthy lack, which is why I would like to see the index I developed with my former colleagues at the Fed made accessible to the public. To the best of my knowledge, the Fed is seriously considering publishing the index on its website regularly."
Oliner's last position at the Fed was senior adviser at the Division of Research and Statistics. He and his colleagues examined 180,000 land deals, which were defined as the sale of an empty lot or a lot with buildings slated for demolition, in 23 areas in the US in 1995-2009.
If you thought that home prices in the US were volatile, you haven’t seen the graph of land prices, which rose fairly modestly in 1995-2002, but then jumped by an average of 135% in 2006, and by even more in East Coast cities. The bursting of bubble in that year sent prices down by more than 50% by mid-2011.
The home prices index includes the price of land and the cost of construction. The fact that land prices rose and fell much faster than home prices (according to the Case-Shiller Index) in the current business cycle indicates that land prices are more volatile.
Oliner attributes this to "supply rigidities". "When demand for homes or commercial real estate grows, the supply of zoned land does not increase at the same rate as the number of workers or the amount of building materials. As a result, land prices tend to rise much more than the prices of other new construction inputs."
Should zoned land be a rationed product that drives up the price?
"That's a tough question. I think that regulatory review is required when land is rezoned. In the US, the changes mostly include the release of farmland at city margins for residences and commerce. This is a sensitive issue because the value of farmland is derived from its use to produce food, as well as for protecting open spaces. Uncontrolled changes are liable to result in urban sprawl, and we've seen ever-worsening traffic problems in constantly growing cities.
"On the other hand, landowners want to protect property values, so they aren’t interested in increasing the supply, even if there is a social advantage. There are places where the land shortage is clearly dictated by the interests of landowners and homeowners. But there is no need to go to the opposite extremes and not examine land rezoning at all."
It is odd to talk about land shortages in the US.
"The issue is not a shortage of land, but of deciding the best use for it. Opinion in the US about the direction of development is changing. There is a switch to the redevelopment of urban centers, partly because baby boomers whose children have grown are not interested in continuing to live in a big house in the suburbs. In addition, for municipalities, population density reduces necessary investment in highways and railways. It also creates a vibrant urban environment, which is something that we in the US are beginning to appreciate. In this sense, we are now catching up with the rest of the world."
Oliner currently serves as a resident scholar at the American Enterprise Institute. He advises lenders and borrowers to take into account the huge volatility in land prices when using land as collateral and on setting financing rates. In addition, in areas where land value is a large part of a home's price, he emphasizes that loans should be granted especially conservatively.
"The Fed is definitely worried about the day a reduction in quantitative easing is announced, even if is a drop in purchases to $60 billion a month from the current $85 billion," says Oliner. "This will be a serious challenge, because the market has a tendency to over-react to any major change by the Fed. The market will conclude, mistakenly, in my opinion that a halt in purchases also means a halt in expansionist policy in general, including interest rate policy, more quickly than the Fed believes."
Oliner visited Israel to attend the 2013 American Real Estate and Urban Economics Association International Conference held on June 23-26 at the Hebrew University in Jerusalem. He participated in a panel on monetary policy after the global crisis together with governors and several officials of central banks from around the world.
Negligible US interest rate until 2015
"The central bank really tries to manage market expectations, but it is not easy to communicate with the public, especially when working on two monetary fronts. Ending expansionist policy in the coming years will be a pothole-filled road," says Oliner.
The second front that Oliner talks about is the US interest rate, which most members of the Board of Governors of the Federal Reserve System believe will remain near zero until 2015. "The Fed has set thresholds, the crossing of which will set off a debate on raising the interest rate. An unemployment rate of 6.5% is one of them. The second, in general, is that inflation should remain under control. Since the unemployment rate is currently 7.5%, we are far from the unemployment threshold, and therefore from an interest rate hike," he says.
"It should be remembered that these thresholds are relevant only for interest rate decisions, and not for bond purchases, for which no quantitative threshold has been set," says Oliner. "The Fed will begin to reduce its purchases at the same time as a sustainable improvement in the labor market. We're not there yet, but if there will be several good monthly job figures later on, I see this happening in the fall, possibly in September."
"I believe that the purchases will stop altogether in the first half of 2014 and that the interest rate will remain negligible into 2015."
Published by Globes [online], Israel business news - www.globes-online.com - on July 1, 2013
© Copyright of Globes Publisher Itonut (1983) Ltd. 2013