Toronto Star blogger, Cam Harvey, a professor of international business at Duke University hard has taken a hard look at the U.S. economy and the probable effect of a second round of quantitative easing (QE2) announced by the Federal Reserve on November 4. His analysis highlights key problems in the U.S. housing market which will challenge the effectiveness of QE2, factors which distinguish Canadian banks, home mortgage and housing markets from their U.S. counterparts.
Professor Harvey, a native-Torontonian, argues on his global finance blog that the newly-announced QE2 is like “throwing stones not shooting bullets,” and that this latest stratagem from the Fed will only have a “trivial effect” on interest rates and is, thus, unlikely to resuscitate the comatose U.S. housing market – the chief underlying drag on consumer and corporate spending.
“So what if (U.S.) mortgage rates are reduced by 25 basis points,” asks Prof. Harvey. “Will this breathe life into the housing market?” He concludes that is “very unlikely” to happen. “Rates are already cheap,” he points out. “People don’t want to buy a house because they know that there is both a huge inventory of unsold houses today and another wave of shadow inventory coming in the future as foreclosures continue. The risk of housing prices going down further is massively more important than a mortgage that is 25 basis points cheaper. Furthermore, there is a huge number of consumers that cannot refinance and take advantage of cheaper rates because they owe more on their mortgage than their house is worth.” This has been the case before QE2 and will be the case thereafter, he concludes.
As a result, QE2 is unlikely to have a huge the housing and foreclosure fiasco, and will not increase consumer spending, according to Prof. Harvey. While conceding it is possible that there could be “a trickle down effect whereby consumer credit rates are reduced a little bit,” he notes that “consumers are worried about the decreased value of their housing stock, their ability to hold onto a job, and, eventually, building up their savings.” “This is not the time to go on a consumption binge,” he concludes.
In Canada very few mortgages are underwater, whereas in the U.S. one-in-four homeowners owe more on their mortgages than their houses would sell for. And, this, in rattled real estate markets that seem to be inevitably headed lower due to the high stock of foreclosed homes (as well as a ‘shadow inventory’ of homes that are now mired in the foreclosure process, but which will inevitably further saturate moribund markets).
Canadian mortgage and housing markets will not be directly affected by QE2. The question affecting Canadian homeowners and prospective purchasers is how long interest and mortgage rates will remain at their current low levels while the Bank of Canada waits to see what effect QE2 will have on the closely tied U.S. and Canadian economies.
