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Harvard Economist Feldstein Warns of Rate Hikes and Housing, Market Falls

By Dan Weil   |   Wednesday, 30 Jan 2013 10:50 AM

At some point, the Federal Reserve will finally have to raise interest rates, and the results won’t be pretty for the economy and the housing and financial markets, says Harvard economist Martin Feldstein.

The Fed has said it plans to lift its federal funds rate target — now at zero to 0.25 percent — when the jobless rate falls to 6.5 percent. In December, the unemployment rate was 7.8 percent.

Right now, with the 10-year Treasury yield at 2.02 percent, the inflation-adjusted yield is really negative, notes Feldstein, who was chairman of President Ronald Reagan’s Council of Economic Advisers.

Editor's Note: Prophetic Economist Warns: “It’s Curtains for America.” See Evidence.

“If we take long-term bond rates to anything like a normal number, that means higher bond interest rates, higher mortgage interest rates, pressure on the stock market and pressure on house prices,” he tells CNBC.

It doesn’t matter whether the Fed is able to raise short-term rates in an orderly fashion, Feldstein says. “Orderly is fine, but it still has to mean higher interest rates,” he points out.

“Once the market begins to focus on the fact that loan rates are going back up, we're looking at a 4 or 5 percent 10-year Treasury yield. That will have an important impact on mortgage rates, house prices and the prices of other interest-rate sensitive assets.”

A Fed tightening also could spark inflation. “What worries me is the possibility that inflationary pressures could build up when the economy is still looking at high levels of unemployment,” Feldstein notes.

“It will be a challenge for the Fed to raise interest rates in a timely way. I think that could lead to inflationary pressures, which would contribute to higher long-term rates simply out of expectations of inflation.”

The housing sector is in the midst of a rebound, with the S&P/Case-Shiller index showing home prices rose 5.5 percent in November from a year earlier. But Feldstein believes the Fed is artificially propping up the residential real estate market.

“I'm not sure that is such a good thing,” he tells CNBC. Once the Fed pulls back on its easing, it may pull the rug out from under the housing market. “This could be a false bounce back in house prices.”

The Fed has played a role in pushing stock prices to five-year highs as well, Feldstein says. “But you can't keep it up by keeping interest rates down, especially as the market asks, what will happen next? Aren't we going to see an exit at some point in which interest rates have to rise?”

As for when that will happen, “I'm not sure,” Feldstein says. “It could be 2014, 2015. Of course, everybody is super smart, everybody knows they'll get out before it happens. That's what they said in 2006 and 2007. It turns out when the market goes, it goes very fast.”

Feldstein believes the Fed has gone too far with its monetary accommodation. He approved of the Fed’s initial quantitative easing, which began in November 2008, as the banking system was in disarray.

But, “after a while, the risks outweigh whatever the benefits are,” he explains. “Clearly, as we saw with today's GDP [gross domestic product] number. Although it [Fed easing] pushes up housing . . . it’s not enough to get the economy moving.”

GDP shrank 0.1 percent in the fourth quarter.

Feldstein isn’t the only economist who’s dubious of Fed policy. Stanford University’s John Taylor, former Treasury undersecretary, feels the same way.

“At the very least, the policy creates a great deal of uncertainty,” he writes in The Wall Street Journal. “The Fed's excursion into fiscal policy and credit allocation raises questions about its institutional independence and accountability.”

Editor's Note: Prophetic Economist Warns: “It’s Curtains for America.” See Evidence.

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