Long Term Rates - When Certainty Can Hurt

The Federal Reserve's latest proclamation -- that short-term interest rates would be kept near zero through mid-2013 - might discourage home buying. Could this be possible

When Certainty Can Hurt
This might seem like a backwards idea. To be sure, the last thing that the Fed would aim for is to make the housing market worse off. So why would it allow one of its policies to keep home sales artificially low? This might be an unfortunate and unintended consequence of its desire to calm the broader market.

The logic works here because home prices are declining. Nobody is sure how far they might fall or when they'll finally hit bottom. But we can feel fairly confident that prices aren't there yet. But what do we now know? Interest rates will be low for another two years. So why hurry to buy a home now?

Savvy potential home buyers who can wait the market out now have a good reason to do so. They don't have to worry about interest rates rising before the market bottoms. Instead, they can wait for the market to continue to decline. If it appears to bottom out in the next two years, then they can step in and finally buy at that time. But if prices keep declining over this period, then they'll be smart to buy in the first half of 2013, just before interest rates might begin rising. In the near-term, you might be better off waiting.

This actually makes a lot of sense. Prior to the Fed's August revelation, one of the best arguments for why it might make sense to buy a home in the near future was that interest rates will rise. As long as the Fed is holding them down, then this argument begins to disintegrate.

Some Reasons to be Skeptical
But there are a couple of reasons why the Fed's action might not endanger home sales.

Mortgage Interest Tracks Long-Term Rates
First, the Fed's action specifically targets short-term interest rates. They'll certainly be very low through mid-2013. But a 15-, 20-, or 30-year mortgage will face prevailing long-term interest rates. While short-term interest rates often have some influence over longer-term rates, the two aren't always directly correlated. In other words, we could see longer-term interest rates begin to rise even as short-term rates are kept low.

For example, in October, the government may no longer guarantee very large mortgages in some markets. That should cause their interest rates to rise a little, since banks and investors will add a default risk premium to those rates. These and other market shocks specific to housing or longer-term rates could still affect mortgage interest rates.

Home Price Movements Are Regional
Second, home prices may continue to decline nationally, but some markets will stabilize faster than others. Some already appear to be healing. So the question of whether to take advantage of low interest rates really depends on where you want to buy a home. In worse-off markets, it may be wise to wait. But in markets showing signs of recovery, low rates might make now the perfect time to buy.

Will the Fed's Words Do More Harm Than Good?
Entire Article: http://www.theatlantic.com/business/archive/2011/08/is-the-fed-preventing-a-housing-market-rebound/243813/