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42 FREDDIE MAC: FED'S MONETARY TIGHTENING WILL NOT ADVERSELY AFFECT HOUSING As 2016 begins, the jury is still out on what the effect of last month's long-awaited federal funds rate increase by the Federal Reserve will be on the economy, and on housing in particu- lar. Some analysts have expressed concern that the Federal Reserve's monetary tightening will reduce affordability, raise mortgage rates, or oth- erwise reverse the gains that housing has made in the last year. According to a commentary by Freddie Mac Chief Economist Sean Becketti, however, Freddie Mac does not share those concerns about the feared adverse effects of the Fed's monetary policy on housing. For one, he said, the Fed has committed to a gradual pace of monetary tightening because the central bank is aware that the U.S. economy is still fragile; "We take the Fed at its word and expect only a few modest hikes in short-term interest rates next year," Becketti said. Also, Becketti pointed out, the link is tenu- ous between the long-term rates (which includes mortgage rates) and short-term rates that the Fed controls. In the mid-2000s, before the crash, mortgage rates hovered around 6 percent despite the fact that the Fed raised short-term rates for 17 consecutive meetings. Furthermore, increases in long-term rates will be limited by weakness in the global economy and a stronger dollar which will attract global capital flows to Treasury securities, Becketti said. e Fed will further be incentivized to moderate the pace of monetary tightening due to plummeting oil prices and the stronger dollar which will limit inflation. "In spite of these headwinds, longer-term interest rates will start to increase in 2016 as the monetary tightening starts to impact economic activity, but the increases in rates like the mort- gage rate will be just a fraction of the increase in the federal funds rate and other short-term rates," Becketti said. "However, even a modest increase in mortgage rates will reduce afford- ability, especially for first-time homebuyers and low-to-moderate income borrowers. is reduc- tion in affordability may restrain house price increases at the lower-priced end of the market." A reduction in the Fed's Quantitative Easing (QE) Portfolio could result in an increase in long-term interest rates, but that does not fit with the Fed's public commitment to gradual monetary tightening. "We don't expect the Fed to shrink the QE portfolio until the latter part of 2016 at the earliest, and any significant reduc- tion in the QE portfolio isn't likely until 2017," Becketti said. While Freddie Mac is optimistic about housing for 2016, there is some uncertainty with regards to the broader economy, Becketti said. While the start of the Fed's monetary tightening indicates that the central bank believes the U.S. economy is on track, the post-Great Recession performance of the economy has been the weak- est post-World War II. Also, real GDP growth is likely to be no more than 2.5 percent, and that is the best case scenario; this is well below the 3.2 percent annual GDP growth the economy has averaged since World War II. DISTRESSED SALES WAY DOWN DESPITE SLIGHT SEASONAL UPTICK Distressed residential home sales, which include both REO properties and short sales, continued their steady decline nearing the end of 2015 despite an expected slight seasonal increase due to seasonality in the market, according to data released by CoreLogic. e distressed sales share has been on the decline for nearly seven years, since reaching its peak of 32.4 percent in January 2009. For October 2015, that share was reported at 10.2 percent, less than a third of its peak share from nearly seven years ago. While seasonality produced a slight uptick of 0.2 percentage points in the distressed sales share, that share dropped by two full percentage points year-over-year in October 2015. Despite being reported at one-third of its peak, the distressed sales share remained elevated in October 2015—about five times its pre-crisis average level of 2 percent. CoreLogic estimates that if the distressed sales share continues to de- cline at the rate at which it did in October 2015, it will reach that pre-crisis average of 2 percent by the middle of 2019. REO properties represented 6.9 percent of all residential home sales in October 2015, slightly less than one-third of their peak of 27.9 percent, also reached in January 2009. Oc- tober 2015's REO share was down 1.6 percent from October 2014, and it was the lowest REO share for any October since 2007. Likewise, short sales were way down in October, accounting for about 3.3 percent of all residential home sales. e short sales share fell below 4 percent in mid-2014 and has remained below 4 percent ever since, accord- ing to CoreLogic. All but nine states experienced year-over-year declines in the distressed sales share in October 2015, according to CoreLogic. e state with the highest share was Maryland, at 20.3 percent; sec- ond was Michigan with 19.6 percent, followed by Florida (19.3 percent), Connecticut (19.1 percent), and Illinois (17.9 percent). e state with the lowest distressed sales share was North Dakota, with 2.7 percent, and Nevada experienced the largest decline year-over-year in October 2015 in distressed sales share with a drop of 5.7 percent- age points. e state that experienced the largest decline from its peak distressed sales share was California (a drop of 59.1 percentage points from its peak 67.4 percent in January 2009). Despite all the steady and substantial declines, only North Dakota and the District of Columbia were within one percentage point of their pre-crisis distressed sales levels. Out of the 25 largest core-based statistical areas based on loan count, the area with the highest distressed sales share was Orlando, Florida, with 21.8 percent. Tampa was second with 21.1 percent, and Baltimore was third with 20.7 percent. Miami (20.6 percent) and Chicago (20.5 percent) rounded out the top five. All but nine states experienced year- over-year declines in the distressed sales share in October 2015.

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