Bankrate.ca

 

September 25, 2013

 

Title: Why tapering matters

Subtitle: Continued Federal Reserve intervention should continue to support Canadian housing

 

Canadian house prices surged by 8.1 percent last month to an impressive $378,369, as measured by the dollar value of the average sale via the Canadian Real Estate Association’s Multiple Listing Service. Not surprisingly, housing starts remained strong too, trending at 187,187 units, roughly unchanged from the previous month.

 

The main driver of the continued strength goes to a group of unheralded Washington gnomes, led by Ben Bernanke, chairman of the US Federal Reserve, who are quietly undertaking a monetary policy revolution. Through a series of unconventional purchases of federal and private sector bonds, known as Quantitative Easing, they are applying downward pressure on real interest rates in both the United States and Canada. This has drastically kept down home ownership costs.

 

Last week, Bernanke announced that “tapering” of Fed purchases, which he had led markets to believe was imminent, would be put off. This has left Canadian housing sector stakeholders guessing as to what will happen next.

 

Beyond a “near zero” interest rate policy

True, Quantitative Easing’s effects have been mostly felt in the United States, where house prices have made a complete turnaround from the post financial-crisis lows, rising by 12.4% year-over-year last month. However the spillover is evident in Canada too, where monetary policy moves just about in lockstep with the US. That means low interest rates there, almost inevitably push down borrowing costs here, which in turn provides excellent support for residential real estate.

 

Bernanke’s retreat on plans to taper the Fed’s bond buying (which to be fair, he had attached plenty of conditions to), provides an excellent excuse to review where the North American economy sits, in a broader historical context.

 

For decades the Federal Reserve broadly controlled the US money supply, by increasing or decreasing its policy rate interest rate. Feb policy has been to try to achieve a balance between low unemployment, and monetary stability, which it defines as low inflation.

 

However starting during Alan Greenpan’s two-decade reign in 1987, the Fed gradually adopted a far more interventionist policy. In crisis after crisis, starting with a stock market crash the year Greenspan took office, through to the failure of Long Term Capital Management in 1998, the tech bubble, the events of 911 and the Iraq War in 2003, the Fed’s response has been consistent: to flood the market with more money. 

 

This policy continued under Bernanke, who has earned the nickname “Helicopter Ben,” for comments he made regarding how an economy could be boosted by a central bank dropping money from a helicopter.

 

At first glance, the Fed’s policy appears to be have been a success having precluded recessions and softened those that did occur in the early 1990s, early 2000s and in 2008-2009. As a result few North Americans now have a clue at just how bad an economy can get. For example US unemployment peaked in just the 10 percent range during the most recent recession, the worst since World War II, far better than totals reached during the great depression and the 25 percent range that recently hit Greece and Spain.

 

The immediate takeaway in Canada is that Bernanke’s decision to postpone tapering will likely continue to provide support to a housing market, which many feel is in overvalued territory. Over the longer term, it will leave housing sector stakeholders wondering where this uncharted path the Fed is taking us on, will lead.

 

peter@peterdiekmeyer.com

 

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