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3 reasons why the Fed is worried about housing

6:07 AM, Jul 18, 2013   |    comments
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If you take away one thing from Federal Reserve chairman Ben Bernanke's testimony to Congress Wednesday, it's this: The Fed really, really wants the housing rally to continue.

During his testimony to the House Financial Services Committee, Bernanke mentioned that financial conditions had tightened recently. Currently, the fed funds rate is close to zero, and the Fed has continued to buy mortgage securities in its bid to keep long-term interest rates low.

So which financial conditions have tightened recently? Thirty-year fixed mortgage rates, which soared from 3.35% on May 2 to 4.51%, that's what. Rates rose, in part, due to thebond market's fears that the Fed would stop its bond-buying program, known as quantitative easing.

The increase in rates means that principal and interest payments on a $200,000 mortgage would rise from $881 per month to $1,015 a month.

Why does that matter? Low mortgage rates are a powerful stimulant to the economy:

• New housing demand. When rates are low, more potential buyers enter the market, creating demand for new housing. You need skilled labor, and lots of it, to build a house. Rising employment in the construction industry would help reduce the overall unemployment rate - and, since employed people can spend money, it would stimulate further growth.

• Existing housing demand. When you move into a house - new or existing - you don't just throw your furniture into the new place. Typically, people paint, redecorate and add on to the places they live, all of which means greater demand for paint, lumber and furniture stores.

• Refinancing. If you had a $200,000 30-year mortgage at 5% interest, your interest and principal payments would be $1,136 a month. Refinance at 3.35% interest, and you save about $250 a month, which you can use to pay down other debts, save, or spend.

As interest rates have risen, however, the booming housing market has shown signs of wobbling. Housing starts fell 9.9% in June - a somewhat misleading figure. "It was more weather-related," says Sam Bullard, senior economist at Wells Fargo. "We got a ton of rain here in the East."

Other indicators are not so benign, however. "Refinancings have dropped 46% from a year ago," says John Lonski, chief economist at Moody's Investor Services. And, while homebuilding permits have outpaced housing starts, permit applications have fallen the past two months, to 911,000 in June from 1,005,000 in April. "That's not a good sign," Lonski says.

Mortgages aren't the only area affected by the rise in rates since May. Issuance of new high-yield bonds - long-term IOUs issued by companies with low credit ratings - "has been horrible since May," Lonski says. In the first five months of the year, high-yield bond issuance averaged $44.3 billion a month. In June? $14.5 billion. Many new or struggling companies use high-yield bonds to start or stay afloat.

John Waggoner, USA TODAY

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