Home / Commentary / Ask the Economist: How Have Zero Interest Rates Affected the Housing Industry?
Print This Post Print This Post

Ask the Economist: How Have Zero Interest Rates Affected the Housing Industry?

Rodney Ramcharan head shot

Rodney Ramcharan

Rodney Ramcharan is an Associate Professor of Public Policy and Research Director of the USC Lusk Center for Real Estate. Previously, Dr. 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.

How has housing been affected by the near zero Federal Funds Target Rate?

One, for those people who have ARMs (Adjustable Rate Mortgage Contracts) have gotten tremendous benefits, because the zero interest rates tend to move in lockstep with the short rate and the LIBOR rate. That has come down considerable with zero interest rates, and so those people who were lucky enough to get into ARMs have benefited tremendously—thousands of dollars a month in savings.

In addition to bringing down the short interest rate, Federal Funds rate, policy interventions like the maturity enhancement program, QE (quantitative easing), which have also worked to bring down the long rate, that has helped people to get into the 30-year fixed rate at a lower interest rate than they would have been able to. For those people who have the credit rating who can get a mortgage, have benefited tremendously from having low long-term rates as well.

I think all of that has generally been reflected in the price of housing. We saw a collapse in housing, but it's beginning to stabilize and it's going up again. I think a lot of that comes from Fed policy.

If the Fed raises the rates by the end of the year by 25 basis points, how is housing going to be affected?

It depends on the context in which they're raising these rates. A 25-basis point increase is sizeable. That is not insignificant if you have a mortgage. That makes a big impact on your monthly payment. On the short end, for people with ARMs, you're going to see an increase. What we don't know, and what is perhaps more important with the 30-year fixed—the most popular mortgage out there—when the Fed acts on the short end of the U-curve, we don't know what's going to happen on the long end of the U-curve. It may be that the Fed says we're going to raise the Federal Funds rate, which is the short rate the Federal Reserve controls, by 25 basis points. It may be that the guidance associated with that rate movement is that the economy is getting much better and investors expect the typing cycle to begin and the 10-year rate jumps by 50 basis points. That means it's going to have a sizable impact on the mortgage market, because you're talking about people getting 30-year fixed contracts and seeing that interest rate going up sizably—more than 25 basis points.

Janet Yellen, Chair of the Board of Governors Federal Reserve System

Janet Yellen,
Chair of the Board of Governors
Federal Reserve System

Do you think that will drive the homeownership rate down? It's already at its lowest point in five decades.

If the economy is really strengthening a whole lot and income growth is very strong, this kind of interest rate movement is going to be somewhat detrimental but not huge. But if the Fed gets this wrong, meaning if the economy is puddling around and income growth isn't so strong and then the Fed raises rates, that can be really big. That can be sizable.

Why has the Fed been reluctant to raise rates for so long?

Economic growth has been very week. The average GDP growth before the financial crisis was around 3 or 3.5 percent. After the crisis, it was about 2 percent. That's a sizable slowdown. Unemployment has come down—we started the crisis somewhere around 9 or 10 percent and that's come down to 5 percent—but what's going on is unemployment measures people who are in the workforce, actively searching for a job. Part of why it's come down is lots of people have just stopped looking, so the utilization rate of the labor force has changed. Thirdly, we haven't seen a lot of wage pressure. It isn't the case that the median income or wages are rapidly going up that would cause the Fed to worry about inflation. I think that combination of factors has led them to be very slow in raising interest rates and has kept them at zero for a long time.

The GDP increased at a rate of 3.9 percent in Q2, which is around pre-crisis levels. Do you think the Fed will increase rates either later in October or in December?

It is not in the interest of the Federal Reserve to shock markets. They do not want to all of a sudden raise rates. I think what they're trying to do is a communications strategy that has been very deliberate in trying to telegraph to markets the interest rate increase. I think they want markets to internalize their transition, and (Fed Chair Janet Yellen) has said in a couple of speeches to expect a 25 basis point increase by the end of this year, assuming that the data is supportive of that kind of move. So an increase in interest rates is very likely.

About Author: Brian Honea

Brian Honea's writing and editing career spans nearly two decades across many forms of media. He served as sports editor for two suburban newspaper chains in the DFW area and has freelanced for such publications as the Yahoo! Contributor Network, Dallas Home Improvement magazine, and the Dallas Morning News. He has written four non-fiction sports books, the latest of which, The Life of Coach Chuck Curtis, was published by the TCU Press in December 2014. A lifelong Texan, Brian received his master's degree from Amberton University in Garland.

Check Also

Wells Fargo Names New Chief Revenue Officer

Wells Fargo announced today that Derek Flowers has been appointed the company’s Chief Risk Officer, effective immediately. Flowers ...

Your Daily Dose of DS News

Get the news you need, when you need it. Subscribe to the Daily Dose of DS News to receive each day’s most important default servicing news and market information, absolutely free of charge.