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Fed Options Hobbled By Tough Jobs Market & Falling Income

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Home prices during the past year have risen significantly but can prices continue to increase? More and more the answer has a lot to do with employment levels and income as opposed to bricks and mortar.

Let's start with income. As a country we have less of it.The latest figures from the Census Bureau show that the median household income was $51,017 in 2012. That's about the same as 2011 — but 9 percent lower than in 1999. If incomes are going down how can people afford homes with higher values and bigger monthly mortgage costs? One way would be for interest rates to fall but interest rates today are higher than 2012. The combination of higher rates, rising home prices and reduced incomes raises major affordability problems for millions of households.

The catch is that interest rates could go still higher, thus creating less affordability. The Federal Reserve says at some point it will reduce monthly purchases of mortgage-backed securities and Treasury securities, going from $85  billion per month to something less. When will this happen? Once the unemployment rate falls to 6.5 percent or less. By reducing its monthly purchases the Fed will cause interest rates to rise, as has already happened in response to general worries about so-called tapering, a fancy term for smaller monthly Fed  purchases.

The Coming Fed Losses
The 6.5 percent unemployment goal seems curious because the Fed is not known for its support of labor. It exists to reinforce the banking system, something it has done with banker-only loan rates at zero percent and massive purchases of bank securities.

Once the Fed stops buying long-term securities interest rates will rise. This is not  good for the housing sector, which remains fragile, and it's also not good for bond holders. When interest rates rise bond values go down. This is a particular problem for the Fed itself because as of September 19th it owned mortgage-backed securities worth $1.337 trillion and notes and bonds worth $1.947 trillion. If interest rates rise the current market value of the Fed's securities will tumble, at least on paper. In practice the Fed can avoid actual losses by holding its investments to maturity — and by not buying more securities.

Third, federal unemployment figures grossly distort marketplace realities so relying on them is fairly pointless: For August the Bureau of Labor Statistics said the national unemployment rate stood at 7.3 percent — but only if we don't count the 2.3 million individuals who were "marginally  attached" to the labor force.

Employment Versus Job Quality
Not only is the unemployment rate the by-product of strange and unusual accounting, it does not reflect the quality of the jobs which the employed are holding.

According to Mintel, an independent research and market intelligence provider, the employment situation is far more dire than government figures suggest.

"Some 7 percent of Americans working full-time have taken a job with a lower skill in order to have employment," explained the new Mintel research report. "In addition, 5 percent are involuntarily working part-time rather than full-time and 2 percent were forced to retire. Many workers (17 percent) say their take-home pay is less today than it was a few years ago. This rate is highest for adults 45-54, at an age when they should be at their peak earning power and have the greatest expenses (children living at home or in college)." (Parenthesis theirs)

So how many people are underemployed?

"Using Mintel’s broader definition," says the company, "that includes those who are working for less pay or at a job with lesser skills, the 'underemployed' estimate reaches 63.2 million."

Right  now the real estate market is powered by such things as low mortgage rates, pent-up demand; a new FHA loan program that allows borrowers to re-enter the market 12 months after a foreclosure; and the massive REO-to-Rent programs undertaken by Wall Street firms in a number of specific markets.

But what about the 62 million people identified by Mintel as being underemployed or fully job-free? With better times how many more homes could they buy? How much higher would home prices rise?

We've done a great job restoring the banks to financial health, but to finish the  recovery much more of the workforce needs to benefit. Since the Fed is now so interested in the unemployment rate, where is it's plan to help workers and thus the economy in general and the housing sector in particular?

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