The Federal Reserve hasn’t had much success so far in wrestling down sky-high inflation, but its monetary tightening campaign is having a major impact in deflating asset bubbles that swelled during the pandemic.
• The cryptocurrency market — once valued at $3 trillion — has shrunk by more than two-thirds.
• Investor-favored technology stocks have tumbled by more than 50%.
• Red-hot housing prices are falling for the first time in 10 years.
Most importantly – and surprisingly – all this is occurring without upending the financial system.
“It’s astonishing,” said Harvard University professor Jeremy Stein, who as a Fed governor from 2012 to 2014 paid special attention to financial stability issues. “If you told any one of us a year ago, ‘we’re going to have a bunch of 75 basis-point hikes,’ you’d have said, ‘Are you nuts? You’re going to blow up the financial system.’”
Fed policymakers have long shied away from using monetary policy to address asset bubbles, saying interest-rate hikes are too blunt a tool for such a mission. But the current deflation in asset prices could help achieve the soft landing in the economy Chair Jerome Powell and his colleagues are seeking.
A broader financial blowup can’t be ruled out. But the current episode for now marks a sharp contrast with the bursting of the US property-price bubble that triggered a deep downturn from 2007 to 2009, and the tech-stock meltdown that helped push the economy into a mild recession in 2001.
Partly in recognition of the risks – and the fact they’ve already raised interest rates a lot – Powell & Co. are primed to throttle back rate increases to 50 basis points next week, after four straight 75 basis-point moves.
Here’s how their campaign has helped affect asset markets so far:
Housing Cooldown, Not Meltdown
Ultra-low borrowing costs, along with a surge in demand for properties outside of urban centers during the pandemic, saw housing prices soar. Those are now coming down under the weight of a more-than-doubling in mortgage rates this year.
Financial reforms instituted after the financial crisis helped ensure that the latest housing cycle didn’t feature the kinds of loosening in credit standards seen in the early 2000s. The so-called Dodd-Frank measures have left banks much better capitalized, and much less leveraged than they were back then.
Banks are also awash in deposits, courtesy of the excess savings that Americans built up while holed up during the pandemic, said Wrightson ICAP LLC chief economist Lou Crandall.
“This housing downturn is different from the 2008 crash,” Bloomberg chief US economist Anna Wong and colleague Eliza Winger said in a note. Mortgage credit quality is higher than it was then, they wrote.
While nonbank lenders – so-called shadow banks – have become a massive new source of credit in US housing in recent years, the mortgage market still has an effective backstop in the form of the nationalized financiers Fannie Mae and Freddie Mac.
“Maybe we shouldn’t be surprised that housing isn’t more disruptive to the financial system — because we federalized it,” said former Fed official Vincent Reinhart, now chief economist at Dreyfus and Mellon.