Continuation of the QE3 Could Create New Housing Bubble

By Stevie Duffin Updated on 3/25/2013

By Daniel Duffield

At present, the axiom that history repeats itself may be proven once more, as recent rises in home prices have failed to have any effect on unemployment levels, which would be expected from a strengthening housing market. As a result, a new housing bubble may currently be forming in the U.S. market, reported Bank of America Merrill Lynch.

Therefore, in contrast to the expectation of a rapid end for the third round of quantitative easing, also known as QE3, the Federal Reserve will now delay such a quick conclusion in the face of growing home values that exceed anticipated levels.

William Dudley, president and chief executive officer of the Federal Reserve Bank of New York, confirmed as much during a speech made on Monday, in which he stated that the central bank will continue with QE3 as a means to continue stimulating the ongoing market recovery.

Particularly, Dudley indicated that the FOMC’s decision to continue with asset purchases will support the recovery effort further by lessening the risk while the labor market is given time to improve. He further added that the FOMC should adjust the amount of purchases to a set number that would provide a notable improvement to conditions in the labor market and by only conducting purchases in consideration of the labor market outlook.

While BofAML conceded that the quantitative easing has had some positive sway in lowering overall unemployment, the bank drew attention to the long-term expense of the program and the quantifiable progress of such a strategy.

Strategists of BofAML Chris Flanagan and Matthew Carr criticized the Federal Reserve’s current actions, stating that, “In particular, by virtue of its willingness to purchase large amounts of treasury and mortgage debt at historically low yields, the Fed appears to be condoning further expansion of such debt, with the obvious irony that it was the expansion of such debt, most notably mortgage debt, that created the crisis in the first place.”

To determine the effects of the QE3 continuation, BofAML constructed a model that would discern whether the Fed could lower the unemployment rate through the purchasing of mortgage-backed securities and lower mortgage rates. However, the results indicated that the housing market could see effects similar to those during the early 2000s and the formation of the last U.S. housing bubble that had devastating effects on the U.S. real estate market and economy.

With the housing recovery growing stronger and stronger, the U.S. should be careful not to allow the mistakes of the previous decade to be repeated, with housing price inflation being used as a tool to lower unemployment.