House Prices and the Possible Fed Effect

Rodney Ramcharan is an Associate Professor of Public Policy and Research Director of the USC Lusk Center for Real Estate. Previously, Ramcharan worked at the Board of Governors of the Federal Reserve System, serving most recently as the first chief of the newly created Systemic Financial Institutions and Markets Section. In that role, he helped develop analyses to understand better the role of financial institutions in the US economy, and contributed to the regulatory policy discussions at both the Federal Reserve and at Basel. His research has appeared in many of the top economics and finance journals, including the American Economic Review and the Journal of Finance. Ramcharan recently spoke with MReport about current house prices, the current state of the market, and the possible effect of Fed action on the market.

When you combine current house prices with other housing and economic fundamentals, how would you assess the current state of the housing market?

I would hate to sound like Pollyanna, but I think it's pretty positive. I think interest rates are low, and house prices are moving in a positive way. These markets tend to have a little bit of built-in momentum in them. It's been positive now for, I think, about six to eight quarters, if not longer. Expectations are it's going to continue to be positive. The only wrinkle in this outlook would be when the Fed begins to raise rates. I think expectations are in December, and that could put things on pause, depending on what the long rate or how the the five year and ten year Treasury yield behave. That is potentially, I think, the only sort of looming factor that could affect the continued growth in house prices.

How would action by the Fed affect house prices?

The causal effect of the impact of the Federal Reserve rates on markets is going to be causally negative, and why I stress that word causally is because you're likely to see a simple positive association between interest rates and housing prices, but I think the deeper effect is going to be a negative one. Let me be clear—it's hard to judge. It's going to depend on what the Fed actually says. If they say that this is a 25 basis point increase as part of a continued spike in interest rates, then that's going to have a bigger effect as opposed to if they say, “We're going to make a 25 basis point increase and wait and see.”

If home price appreciation continues at 5 percent or so for the next 12 months, as is widely forecasted, and a couple of Fed rate hikes are mixed in, what does the market look like?

That's a great question. I cannot give you a definitive answer—I can only give a little bit of a framework to think about it. Just briefly, the Fed is raising rates in expectation that house prices are going to be solid, house price growth. If they get that expectation right, then the impact of the rate increases are going to be minor. If they get it wrong, then the impact could be quite large. Now, I'm hedging here because this is like asking us to forecast the weather six to nine months out. It's really very difficult.

All that being said, I think from where I sit, things look pretty positive. The interest rate pace is going to be well-judged, and house prices are growing quite solidly. If you look at the Case-Shiller index, it's pretty much spread across all of the 20 cities. They're all experiencing some positive growth. That's a pretty good sign that the housing market, broadly speaking, is doing well. There's good reason to be optimistic about where it's going to be in the next year.

What areas of housing do you think need improvement right now?

I think there's the question of affordability. That is something that's going to become more and more pressing as house prices continue to increase. That's not necessarily coming from the Fed, but that's going to depend on what local governments do to ease the building restrictions in some cities to allow people to build more easily. I think that's one thing that could make a difference. That's the main cloud that I would see, which is the flip side of a strong housing market is affordability.