From Jason Payne, Market News Analyst …
Amid no shortage of political drama during recent weeks, President Obama nominated Janet Yellen to succeed Ben Bernanke as chairman of the U.S. Federal Reserve Bank – an important (and encouraging) development for investors of all stripes, including most real estate investors.
By nominating Yellen, the White House has not only selected a longstanding veteran of the Federal Reserve system, widely touted as being the most qualified individual ever picked to lead the central bank, but also extended – at least temporarily – the Fed’s “easy money”, accommodative, dovish strategy for regulating the U.S. financial system.
As the Fed’s current vice chairman, Yellen shares many of the same economic philosophies as her predecessor, and most analysts expect a generally seamless transition of leadership when Bernanke’s heir apparent takes the reigns on February 1, 2014…
…although these continue to be unprecedented economic and political times for both the Federal Reserve and the real estate investors who feed daily at its trough.
Why was Yellen the White House’s Second Choice?
Despite Yellen’s impressive pedigree, the White House was originally inclined to nominate former Treasury Secretary Larry Summers for the Fed’s top job. This preference was primarily due to the polarizing economist’s track record as an undeniably brilliant force of nature on the economic and political world stage.
Adding to Summers’ intrigue and relative appeal, White House insiders indicated to the celebrity-hungry media that his bold and collaborative interpersonal style stood in preferable contrast to Yellen’s reputation as a more reserved and independent thinker.
Unsurprisingly, the national press had a veritable field day with idea of Summers’ prospective nomination. In the ensuing arms race for eye-catching headlines and storylines, some pundits suggested that the controversial public figure represented our nation’s long-awaited economic messiah, while others insisted he was nothing less than the devil incarnate.
However, this unjustified media frenzy was short-lived as several representatives of the Senate Banking Committee soon suggested they would rather swallow razorblades than confirm a Summers nomination. Shortly thereafter, Obama announced Yellen’s nomination, to relatively muted fanfare in the national media.
But don't be fooled by the relatively muted fanfare. While Yellen may lack the personal gravitas of the White House’s first choice, this is no reason to believe that she is somehow ill-suited to become the most powerful economic policymaker on earth...
…nor is there any reason to worry that she poses some unusual threat to real estate investors.
Here’s why.
Groomed by the Fed to Shepherd the U.S. Economy
Janet Yellen has a significant and successful history of shaping domestic monetary policy in the Federal Reserve system.
Founded by Congress in 1913 to provide the U.S. with a safe, flexible and stable monetary and financial system, the Federal Reserve ("Fed") is comprised of a central Board of Governors in Washington, D.C. and twelve regional Federal Reserve Banks.
The Fed’s creation was precipitated by repeated financial panics that afflicted the U.S. economy over the previous century, similar to the type we narrowly avoided during the recent financial crisis of 2007-2008. Those historic panics resulted in severe economic disruptions throughout the 1800s, due to bank failures and business bankruptcies (sound familiar?), and a particularly acute crisis in 1907 led to calls for an institution that would prevent such panics and disruptions in the future.
Accordingly, the Fed’s duties can be categorized into four general areas:
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Executing national monetary policy by influencing monetary and credit conditions, in order to ensure (i) maximum employment, (ii) stable prices and (iii) moderate long-term interest rates.
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Overseeing and regulating the banking industry, in order to ensure safety of the U.S. financial system and protect consumers’ credit rights.
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Maintaining stability and containing systemic risk within the U.S. financial system.
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Providing certain financial services to depository institutions, the U.S. government and foreign official institutions.
After working until 2004 as a professor at several prestigious universities, Yellen assumed the role of president and CEO at one the Fed’s twelve regional banks – the Federal Reserve Bank of San Francisco – where she complemented her academic prowess with six years of practical immersion in each of the Fed’s primary duties. It was during this time at the San Francisco Fed that Yellen is typically credited with foreseeing the subprime mortgage crisis more accurately than her peers at the other regional banks.
Subsequently, in the immediate wake of our latest financial crisis, Yellen was appointed to a four-year term as the Fed's vice chairman under Bernanke. At the same time, in 2010, she also commenced a 14-year term as a member of the Board of Governors…
…thereby securing a prominent voice on the mighty Federal Open Markets Committee (FOMC), which oversees open market operations as the Fed’s primary tool for influencing monetary and credit conditions.
It is this repertoire of stellar credentials which led several Congressional Democrats to push for Yellen’s nomination over Summers’, citing her “impeccable resume, focus on unemployment and solid record as a bank regulator.”
Yellen will Inherit an Unusual Economic Environment
Yellen’s nomination comes on the heels of an especially busy and unusual 5-year period for both real estate investors and the Federal Reserve system, which lends further credence to Washington’s choice of an insider to lead the institution.
In 2008, the U.S. economy was hit by powerful recessionary forces, led by significant declines in housing market fundamentals.
Accordingly, the Fed under Bernanke has spent the last few years adjusting and responding to the crisis in a variety of ways, sometimes being forced to improvise substantially when confronted with powerful and unexpected economic headwinds:
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Reducing Short-Term Rates. On December 16, 2008, the Federal Reserve reduced short-term interest rates to effectively 0%, thereby increasing the availability of short-term “easy money” in an attempt to stimulate U.S. economic growth. However, when low short-term interest rates failed to spur desired economic growth, the Fed quickly implemented its first of several quantitative easing strategies to reduce long-term interest rates, thereby supplementing the availability of short-term easy money with similar long-term accommodations.
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Quantitative Easing #1 (“QE1”). From December 2008 through March 2010, the Fed purchased $1.45 trillion of toxic mortgage-backed securities from Fannie Mae, Freddie Mac, Ginnie Mae and the Federal Home Loan Banks. They also purchased $300 billion of long-term Treasury securities.
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Quantitative Easing #2 (“QE2”). From November 2010 through June 2011, the Fed purchased an additional $600 billion of long-term Treasury bonds.
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"Operation Twist". From September 2011 through December 2012, the Fed spent $667 billion to buy bonds with maturities of 6 to 30 years while simultaneously selling bonds with maturities of less than 3 years.
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Quantitative Easing #3 (“QE3”). Most recently, in September 2012, the Fed began monthly purchases of $40 billion in agency mortgage-backed securities and $45 billion of longer-term Treasury securities.
The monthly investments under QE3 continue to this day, and skittish Fed-watchers increasingly observe that all the aforementioned “easy money” policies have caused the Fed’s assets to approach $4.0 trillion during recent months – an astonishing figure which will continue to increase by $85 billion per month until the Fed eventually begins to “taper” its investments.
Of course, the Fed cannot keep its foot on the gas pedal forever, and economists generally agree that we are closer to the end of this current dovish era than the beginning…
…which has major implications for the next Fed chief (who must decide on the timing and speed of economic deceleration) as well as real estate investors (who have been benefitting from an artificially depressed mortgage rate environment).
To wit, in June of this year, Bernanke’s mere mention of the Fed possibly “tapering” its $85 billion monthly investments sent 10-year treasury yields and mortgage rates soaring, threatening both the housing market’s nascent recovery and U.S. economic growth in general.
How will Yellen's Leadership Impact Real Estate Investors?
During the recent “tapering” scare, Yellen was among the majority at the Fed who quickly scrapped any near-term plans to decelerate QE3’s monthly economic stimulus. Mortgage rates immediately returned to earth on the news (and stocks rallied to new highs) as real estate investors thanked Yellen and her colleagues for their sensitivity.
In fact, Bankrate.com notes that the average rate on a 30-year fixed mortgage has fallen approximately 30 basis points since this summer’s peak, from 4.64% to 4.34%.
Although the next Fed chairman will eventually need to bite the bullet and begin reigning in the institution's current easy money policies, occasions such as this summer's quick response to QE3 concerns have bolstered Yellen’s reputation among investors as a policymaker who will patiently wait until “the right time” to make necessary moves.
Notably, one analyst who recently met with Yellen believes that her leadership would see today’s low interest rates persist until at least early 2015, and any deceleration of QE3 would be limited to a gradual tapering of only $10 billion per month.
Regardless of the specific dates, times and rates of stimulus reduction, it is reasonable for real estate investors to believe that a Yellen-led central bank would allow today’s economic soil to maintain its artificial fertility for at least a little while longer.
Similarly, this low interest rate environment can be reasonably expected to keep mortgage rates in check while greasing the macreconomic wheels for most homebuyers in search of good deals.
So, even if the best days of government-driven stimulus are slightly behind us, Janet Yellen appears poised to extend the housing market’s recovery throughout the near-term future in her new role as chairman of the Federal Reserve.
Here's wishing her – and you – nothing but good fortunes and happy returns in the weeks and months to come.
Jason Payne’s next Market News Update is currently scheduled for Wednesday, October 30th.