The Fed is poised to raise the overnight cost of money (the “Fed funds rate”) a series of times because the rate of core inflation is approaching the Fed’s 2 percent target.
What does this mean for your buyers and sellers?
What to tell clients
Be very careful with any discussion of inflation with clients. Many theorists in markets and theorists outside are given to claims of government conspiracy to under-report inflation (especially right-side bond market types and bankers), or to mis-describe inflation. Others highjack the word to describe rises in asset prices as “inflation.”
I’ve spent a lifetime studying government reports on inflation, and they are as honest as can be, no matter how often they fail to predict the future.
Second, keep clear that there are several types of inflation. The most basic is money-printing, “too much money chasing too few goods and services.” But, even in that classic definition, how can we be sure that prices are rising because of too much money, or too-short supply?
One of the hardest prices to nail down is housing. Less than 5 percent of housing changes hands each year, so even if prices are rising at a given moment, only a handful of people pay the higher ones. And changes in price are hard to nail down to a national average when San Francisco and Denver are hot, but the Plains and Deep South are dead.
Home prices also don’t measure rent, and most tenants must renegotiate price every year. So, consumer price index (and the other dozen measures) use “equivalent rent” instead of price.
What’s happening to the economy — and to housing?
Then we have to figure out what portion of the overall typical household’s spending goes where. The Bureau of Labor Statistics tables are very hard to read, but the Cleveland Fed’s website has a nifty page showing all the components of household spending and each component’s percentage contribution to the overall inflation figure.
Housing is the largest, almost 30 percent. And it’s running almost 4 percent annually.
Is that because money is too easy, and the Fed should hike its cost?
Says here, no. And the Fed should be talking about it. The Fed acknowledges that mortgage credit is still way too tight — cheap as in low rate, but underwriting so tight that it crimps new supply. Any builder will tell you how hard it is to get a loan to develop land, or to build a home “on spec.”
Beyond credit, Ivy Zelman (genius founder of Zelman & Assoc.) has figured out a non-monetary angle. Land itself is too scarce and costly in most metro areas, and cost-pushed by a large array of development fees. Some are justifiable, for infrastructure, or perhaps affordable housing. Others are just for general funds, displaced taxation. At any level they push up the cost of housing, and if too hefty push up prices so far that they inhibit supply.
Inflation aside, one of the mysteries of this achingly slow-motion economic recovery has been the absence of strong new construction. But inflation is not aside. In a commodity like housing, we know for sure that we can overbuild and cause prices to drop, and for equal certainty we can under-build and create an expensive shortage.
If owner’s equivalent rent is rising at almost double the rate of national income growth, it’s not because the Fed has printed too much money, or the Fed should make money more expensive.
Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.
