Why the Federal Reserve Matters

We spend a good deal of time talking about the Federal Reserve, and we do so for a good reason: The Federal Reserve is the most important economic planner in the country. The Fed is charged with promoting employment, stabilizing prices, and regulating the financial sector. Not surprisingly, it holds tremendous sway over both the housing and mortgage markets.

We frequently monitor the Fed to get an idea where lending rates are headed. Last week, we mentioned that we thought lending rates would hold today's lower levels. We've become more convinced that the Fed won't step back from quantitative easing or raise short-term rates soon. We say that because the Fed has targeted a 6.5% unemployment rate and a consumer-price inflation range of 2% to 2.5%.

On the former, the goal isn't close to being reached. Unemployment still runs well over 7%, and it's only that low because of a falling labor participation rate. As for consumer-price inflation, it still runs well below 2%. Much of the new money the Fed has pumped into the economy, instead of flowing into the consumer sector, is finding its way into asset. It's no coincidence that stocks are at an all-time high.

In short, the Fed has plenty of room and plenty of incentive to keep pumping money and to hold mortgage lending rates low. We don't see that changing in the near future.

Keeping you updated on the market! MARKET RECAP For the week of November 11, 2013

The U.S. Census Bureau reported that the homeownership rate hit an 18-year low of 65.1% in the third-quarter of 2013. The rate had climbed steeply in the 10-year period from 1994 through 2003 – topping 69%. From there, it has been downhill ever since.

At the same time, residential rents continue to rise. The Census Bureau also reports that the median residential rental rate rose to $736/month in the third quarter to hit an all-time high.

Home prices also continue to rise, which is mostly positive. The negative is that the strong rise in home prices over the past two years has made it more expensive to buy a home. Home-price increases have helped drive the National Association of Realtor's affordability index down to a five-year low.

Rising rents and rising home prices are pressuring household formation – where a person moves into his or her own housing unit. For decades, new household formation averaged roughly 1 million per year. In the third quarter of 2013, the rate dropped to 380,000 on an annualized basis.

New households are, not surprisingly, associated with first-time buyers – both categories are overwhelming young in age. The percentage of first-time buyers in the market has fallen this year. These buyers historically account for 40% of home sales. But the latest NAR data show these buyers accounted for only 28% of homes bought in September. 

The news appears bad for the housing market, but it really isn't. It's important to emphasize that all markets are forward looking. Where we're going is more important than where we've been. Quite frankly, we like where we are going.

Current household formation at lows and rents at highs point to growth in homeownership rates. Surveys from Fannie Mae still show 75% of us prefer to own a home. Yes, homes are more expensive than they were a few years ago, but the good news is there is pent up demand for a home, particularly when the cost of owning that home is juxtaposed to the cost of renting.

Rising home prices, though lowering affordability, are also positively impacting the mortgage market. Excessively tight lending standards has been a recurring criticism, but there are signs of change.

Rising home prices are putting more homeowners into positive equity positions, which means more homeowners are motivated to service and maintain their mortgage. In fact, the delinquency rate for mortgage loans decreased to 6.4% of all loans outstanding at the end of the third quarter. This is the lowest level since the second quarter of 2009.

Rising home prices and lower delinquencies, in turn, are making lenders less risk averse. Today, we see more loans in the conventional market being originated with down payments as low as 5%. In other words, private lenders are competing with the FHA, and many are even offering better deals when all costs are factored in.

So don't be put off by today's cloudy negative news, because silver linings can be found. The future is what matters, and we see a positive future based on the likely reversal of several negative trends.