Fed Study: House-Price Growth to Be Slow

July 14, 2004

Fed Researchers Say House Prices to Grow at Slowest Pace Since 1970s As Interest Rates Climb

WASHINGTON (AP) -- U.S. house prices are likely to grow at the slowest pace in more than three decades as interest rates climb and land prices take a tumble over the next three years, researchers at the Federal Reserve have estimated in a new study.

 Related Links:
The Price and Quantity of Residential Land in the United States, Morris A. Davis and Jonathan Heathcote (june 2004)

The study, published on the central bank's Web site recently, asserts that if U.S. disposable income and short-term interest rates climb as much as Wall Street expects them to, nominal existing-house prices would increase a cumulative 2.6 percent over the next three years. That would mark the lowest rate since the government began keeping records in 1970. The number implies high odds that house prices will decline in inflation-adjusted terms.

The conclusions validate the unease of many private economists who fear the U.S. housing market, having benefited recently from rapid price gains that helped maintain strong consumer spending through a recession, may become a source of economic instability as interest rates climb.

Prices of existing homes rose by more than 20 percent cumulatively over the last three years, according to the National Association of Realtors. The association has been predicting only a modest slowdown for the next few years.

"Of primary concern to some analysts is whether the recent run-up in aggregate home prices will be somewhat reversed, much like the 1985-90 and 1990-1995 experience," when inflation-adjusted house prices declined in several major metropolitan areas, write the authors of the Fed study, Morris Davis and Jonathan Heathcote. Davis is a Fed economist; Heathcote is an assistant professor of economics at Georgetown University.

They conclude a reversal of those magnitudes -- involving land-price declines of as much as 10 percent -- is likely.

The NAR disagreed with that assessment. "The (house-price) number is just unreasonably low and doesn't match up with the underlying factors, such as the tight supply conditions and very low mortgage rates," said Lawrence Yun, the association's senior economist. He said consumer spending would slow "if that report is correct, and there is a very minimal return that people can expect" from house purchases. The association's own forecasts call for nominal house prices to rise about 15 percent over the next three years.

Fed policy makers have generally rejected the view of commentators who argue that rising U.S. house prices have created a "bubble" in the market that could destabilize the economy if it bursts. The rise of house prices, Fed Chairman Alan Greenspan and other officials have said, is bound to slow as interest rates climb. But they said a destabilizing drop in prices isn't likely.

"Some factors, including increasing prosperity and wealth associated in part with rapid gains in labor productivity and earning power, should help support house prices in the future and thereby reduce the risk of a sizable correction in which prices actually fall across a large number of localities," Fed Governor Donald Kohn said in a speech in April.

The Fed researchers said they studied the question by using data from government-sponsored mortgage giant Freddie Mac, the Census Bureau and the Bureau of Economic Analysis to construct a quality-adjusted price index for the stock of residential land in the United States. They found the formula they developed would have broadly predicted the actual changes in the market values of homes recorded in Census data over the last 20 years.

Copyright: Associated Press

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