"Complacency Would Be Ill-Advised
Federal Reserve Board Gov. Donald Kohn had some bad news for the housing bulls today. "We should not hesitate to raise interest rates to contain inflation pressures just because it might set off a retrenchment in housing prices, just as we were willing to keep rates unusually low as house prices rose rapidly."
Mr. Kohn isn't sure if there is a housing bubble, but this is what he predicts if there is. "If current expectations are badly distorted, then the way forward may not be so smooth. Eventually, reality always asserts itself over wishful thinking, and such realignments are sometimes abrupt, as illustrated by the collapse of the high-tech bubble a few years ago. In such circumstances, asset prices can adjust sharply."
"We have little experience to call on in judging when and how they will be corrected. We cannot rule out sudden shifts in expectations, whether or not they are unreasonable to begin with, and asset prices may change suddenly. Investors may recognize the unsustainability of some flows and prices, but believe they can adjust in advance of the market, as apparently many thought they could in the tech-stock bubble, and their reactions when prices move could add to volatility."
The risk "spread" represents a complacent market, Kohn said. "Although premiums on private bonds relative to Treasury yields have risen somewhat of late, they are still at the low end of their historical range, suggesting that investors are sanguine about default risk and other types of uncertainty."
Everyone should know by now, that there may be a bubble. "Given the widespread press coverage of this issue, from my expectation that people should now be aware of the risks in the real estate market. Complacency would be ill-advised."