How Overly Cautious Investors May Stall the Housing Recovery

by 27 Feb 2013

Everything seems to be falling into place for the housing market in the United States. The Federal Reserve Bank has made good on its commitment to bolster the economy through a series of monetary policies that have kept mortgage interest rates low, median home prices are rising, and major home builders have enjoyed a stellar performance on Wall Street for more than a year.

After several months of gradual recovery, investment analysts are beginning to question just how long the good times will last. The Fed is bound to cease its third round of quantitative easing and mortgage bond purchasing later this year, and investors are already fussing at the prospect of a tighter spread between the origination and secondary mortgage markets. The same goes for American home builders and their impressive bull run since late 2011; it may be losing steam.

Investor Behavior to Blame

Analysts who argue that first-time home buyers are missing from the ongoing housing recovery also point out that the home builder resurgence is mostly due to investors' whim. Things look good for home builders in the short term as inventory levels remain low and there seems to be a rush by house hunters, particularly real estate investors, to acquire homes while the price is still right. Builders are certainly being helped along by the strength of their shares and trading volume, but this alone will not sustain a housing recovery.

Investment analyst Michael Gayed recently appeared on CNBC to discuss a sudden hesitation in the home build bull run on Wall Street, and he followed up with an article on Market Watch that explained things from a behavioral point of view. He argues that the interest in home builders may be due to a behavioral regret bias known as the snakebite effect.

When investors run into bad experiences, such as the catastrophic end of the housing bubble a few years ago, they tend to become conservative to a fault with regard to a certain asset class. As Mr. Gayed sees it, the slowdown by the Fed in purchasing mortgage-backed securities is already pushing interest rates back up. This could have a negative effect on home buyers looking for newly-built single-family residences, thereby affecting the margins of home builders.

With home prices rising in tandem with mortgage interest rates, investors biased by the snakebite effect are likely to abandon hope in the housing market. This does not automatically trigger a bubble, but it may slow down the overall recovery. When strong behavioral biases rule the financial markets, bubbles and major corrections occur.



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