How did we get into this mess? How was the Fed, if you believe ex-boss Alan Greenspan, snookered by loose lending tactics that badly distorted the housing market? Well, see what I stumbled upon, a report from Fed’s N.Y. bank from late ‘04 on the housing market. That was when home prices were prepping for their final push higher as skeptical commentary was bubbling up. The Fed’s conclusion …

The most widely cited evidence of a bubble is not persuasive because it fails to account for developments in the housing market over the past decade. In particular, significant declines in nominal mortgage interest rates and demographic forces have supported housing demand, home construction, and home values during this period. Taking these factors into account, we argue that market fundamentals are sufficiently strong to explain the recent path of home prices and support our view that a bubble does not exist.

As for the likelihood of a severe drop in home prices, our examination of historical national home prices finds no basis for concern. Even during periods of recession and high nominal interest rates, aggregate real home prices declined only moderately. However, weakening fundamentals could have a larger impact on areas along the east and west coasts—where the supply of new housing is believed to be inelastic, home prices historically have been volatile, and home price appreciation has been strongest. In the event of such a weakening, home prices in these areas may fall, as they have in the past. Nevertheless, these past episodes of home price declines—although significant regionally—did not have devastating effects on the national economy.

To read the entire report, CLICK HERE

We asked a few economy watchers around town if the Fed’s quarter-point cut (after a half-point six weeks ago) is the right medicine for an otherwise healthy business climate suffering a bad bout of housing flu …

Andy Policano, dean at UCI’s Merage School of Business: “The cut is just right at this point; it is enough to signal that the Fed is willing and ready to battle malaise, and yet not too much reflecting still the concerns about inflation. The cut should immediately help ease some liquidity pressures. But the main effects on the economy of the accumulated Fed cuts will take something like 6 months to 9 months. The housing market has a way to go, perhaps to middle of 2008, before some recovery is seen.”

Economist at Mark Schniepp at California Forecast: “This continues to restore confidence in the market. Rates may fall some, but more likely the spread between jumbo and conforming will continue to shrink … Home-equity lines of credit loans will be at lower rates. Short-term rates will go lower, a disincentive to save, but an incentive to find alternative investments (but NOT real estate, for God’s sake). GDP growth for Q3 was nearly 4 percent. So, the move by the Fed today was bold — it was just in the interests of the housing market and to get the credit crunchiness reduced as quickly as possible.”

Lender and talk-show host Norm Bour: Average people “should be concerned that these efforts on the part of the government will NOT stop the recessionary pattern we are in. THIS will, I think, cause huge worries. If Uncle Sam cannot ’stop’ the downturn of the economy, the increasing foreclosure activity and the drop in (home) prices, what can? (Average people) will, in turn, feel even more helpless than what they may be feeling now. Hate to sound like a Chicken Little, or a negative prognosticator, but it took MANY years to get to where we are now. And it cannot be fixed by these adjustments. The only thing that can help is time.”

Investment adviser Chip Hanlon: “Based on its comments about inflationary pressures — talk about stating the obvious — the Fed may be setting itself up to pause its rate-cutting campaign at its next meeting, as it well should. … The housing market is already dead and cannot be fixed by Fed action. Now we need the market to fix this mess by way of lower prices. Today’s prospective homebuyers should be very patient and place low-ball offers as prices will almost certainly continue to come down. One must be a real estate agent to believe that now is a good time to be buying a home.”

Broker Bill Plattos at FirstTeam Real Estate: “I think the Fed has a handle on the economy and is doing what is necessary to keep a positive attitude in both our country and world. We will look back and realize this is the beginning of an excellent time to purchase a ‘Hot Buy’ in the real estate (especially if you are looking for a home, not just an investment) for those who like to time the market.”

Real estate investor Buzz Doxey … “Little or no effect on the real estate market as a whole. This is due to, as Sam Zell I believe stated, “We have a crisis in confidence, not an economic problem”. That, in part, is thanks to you, Jon, and your cohorts, as you have almost single handedly brought this market down through the doom and gloom drumbeat daily. … Go out and get the best location that money can buy and let time do
the rest. Remember nobody ever times the market.”

Today, the Fed’s interest-rate policy committee lowered the rates it controls for just the second time in four years. Clearly, a shaky housing market nudged the central bankers to lower the benchmark Fed Funds rate by a quarter-point to 4.5%. The Fed offered up a half-point cut six weeks ago, a move that was the first Fed cut since June 2003. Since that moment, the Fed helped turn easy money into hard-to-get loans by raising Fed Funds from 1% to 5.25% with a string of 17 quarter-point hikes in ‘04-’06. The Fed today also lowered the “discount rate” it charges banks by a quarter-point to 5%. While lowering its rates, the Fed’s comments indicated …

“Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance. However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction. Today’s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.” (The entire Fed statement IS HERE)

Pimco bond guru Bill Gross from Newport Beach told CNBC after the news that “Ultimately, housing dominates the scene.” He thinks a softer economy will force the Fed will eventually cut Fed Funds to as low as 3.5%.

There’s been much debate about what regional economy is suffering the most under the weight of the housing quagmire we’re stuck in. Well, I took a twist on some old school economic math to get a good hint. And by this metric, it’s not the two coasts in the most trouble. Yet.

Yale economist and presidential adviser Arthur Okun (that’s his photo at left) in the 1970s devised what he called the “Misery Index.” It combined that era’s twin pains, the unemployment rate added to the inflation rate, to create a simple scorecard for the national economy. The higher the misery, the logic goes, the worse the business climate.

Fast forward to today, and your blogger created a “Housing Misery Index” to put the current real estate pain into some regional context. It’s a twist on Okun’s idea: we’ll add a state’s mortgage deliquency rate (second quarter, by the Mortgage Bankers Association) to its unemployment rate (August, by the Bureau of Labor Statistics) to see what state economies are suffering the most misery.

This Housing Misery Index shows Mississippi (9.3% delinquencies plus 5.9% unemployment for a 15.2% misery index) in the worst shape, followed by Michigan (7.6% delinquency; 7.4% unemployment; 15% misery index.) Hawaii ranked the best (2.4% delinquency; 2.6% unemployment; 5% misery index) and California was 26th (3.6% delinquency; 5.5% unemployment; 9.1% misery index.)

Here’s the five worst among the 50 states …

.. and the best …

… and the other 40 states …