First of all, with respect to growth, I think we are following the path laid out by the Greenbook toward greater moderation in the second half. The main difference is that, since our last meeting, the uncertainty around that prospective path has increased. Obviously, the key to this moderation is the housing market, and fundamental analysis would suggest that the combination of high prices and rising interest rates would make affordability a problem and would bring housing starts and housing prices down. So far we are seeing, at worst, an orderly decline in the housing market; but there is still, I think, a lot to be seen as to whether the housing market will decline slowly or more quickly. As I noted last time, some correction in this market is a healthy thing, and our goal should not be to try to prevent that correction but rather to ensure that the correction does not overly influence growth in the rest of the economy.

Lenders should recognize that certain nontraditional mortgage loans are untested in a stressed environment; for instance, nontraditional mortgage loans to investors that rely on collateral values could be particularly affected by a housing price decline. Investors have represented an unusually large share of home purchases in the last two years. Past loan performance indicated that investors are more likely to default on a loan when housing prices decline, than owner occupants.

At this point, the available data on the housing market, together with ongoing support for housing demand from factors such as strong job creation and still-low mortgage rates, suggest that this sector will most likely experience a gradual cooling rather than a sharp slowdown. However, significant uncertainty attends the outlook for housing, and the risk exists that a slowdown more pronounced than we currently expect could prove a drag on growth this year and next.

While I don’t think there is much risk of a housing price collapse on a nationwide basis, we could see a decline in prices in certain markets.

The housing market has had an amazing run in recent years...You won’t hear me use the B-word to describe this remarkable activity. Instead, I believe fundamental factors can fully explain the expansion we’ve seen in the demand for housing, particularly rising incomes, rising population, favorable tax treatment, and very low interest rates. At the present time, mortgage interest rates are not as favorable as they were a few years ago, and so it is not surprising that we are seeing some signs of a tapering off of residential activity in many markets. For example, there were 1.28 million new single-family home sales last year, but so far this year the sales rate has averaged 1.14 million. I see this not as a precipitous decline, but rather as a return to more normal conditions in many markets...Looking ahead, it seems reasonable to expect the housing market to remain strong, even as some further tapering off in sales and production takes place.  The key point I would like to emphasize is that the housing phenomenon was not a mysterious, independent boost to the economy, driven by some sort of animal spirits, but instead was a rational response by households to the economic fundamentals, especially very low real interest rates. 

My sense is that Massachusetts and New England will experience some sustained cooling in real estate markets, and some flattening of prices, but this trend is not likely to affect the region overly negatively, and likely not more than the nation as a whole.

A risk to the U.S. forecast would come from a significant reversal of the boom in house prices, which could have a very restrictive impact, especially through negative wealth effects. However, so far, I’d say that we’ve only seen early signs of a cooling off in U.S. housing markets.

Many news reports and anecdotes suggest that the housing market is cooling and that investors are participating less actively. However, the construction of new homes has remained near recent highs.

On the demand side, there is some uncertainty regarding the rate at which housing activity is at all likely to cool in the coming year. Although I do not think that a sharp fall in housing investment is likely, a range of forecasts from flat to moderately declining seem reasonable.

Housing has been an area of strength throughout this business cycle, and we've seen strong increases in home prices...Many analysts warn that housing is overvalued. One way we can judge this is by looking at the price-to-rental ratio for housing...Nationally, the price-to-rental ratio has been rising sharply since the mid-1990s and currently is at its highest level ever. However, the price-to-rental ratio has risen only modestly in Chicago and most Midwestern cities; the largest increases have occurred in cities such as Miami, San Francisco, and Las Vegas. These differences highlight the local nature of housing markets. There is little tendency for housing price declines in a particular region to spill over to a more general drop in prices at the national level...If housing does prove to be overvalued and home prices fall, residential construction would be adversely affected. But history suggests that the impact on overall consumer spending would be more modest. Moreover, the changes in wealth and any related spending adjustments likely would be gradual. 

House prices have risen to levels that, in some areas of the country, seem high relative to the economic fundamentals. The market for second homes seems especially strong, raising the fear that some homeowners are speculating on further increases in home prices. The greater use of innovative forms of mortgage finance adds to the concern that the residential real estate market may well be vulnerable to a flattening of home prices, and in certain markets, perhaps a decline. I do not think that a significant and widespread drop in home prices is the most likely outcome, but the situation will require careful monitoring in the months ahead.

Certainly, analyses do indicate that house prices are abnormally high—that there is a "bubble" element, even accounting for factors that would support high house prices, such as low mortgage interest rates. So a reversal is certainly a possibility.

In the United States, signs of froth have clearly emerged in some local markets where home prices seem to have risen to unsustainable levels. It is still too early to judge whether the froth will become evident on a widening geographic scale, or whether recent indications of some easing of speculative pressures signal the onset of a moderating trend.

The apparent froth in housing markets may have spilled over into mortgage markets. The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other, more-exotic forms of adjustable-rate mortgages, are developments that bear close scrutiny. To be sure, these financing vehicles have their appropriate uses. But to the extent that some households may be employing these instruments to purchase a home that would otherwise be unaffordable, their use is adding to the pressures in the marketplace.

It is encouraging to find that, despite the rapid growth of mortgage debt, only a small fraction of households across the country have loan-to-value ratios greater than 90 percent. Thus, the vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices. In addition, the LTVs for recent homebuyers appear to be lower in those states that have experienced the most explosive run-up in house prices and that, conceivably, could be at risk for the largest price reversal.