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The Fed and your home

THE FEDERAL RESERVE’S EFFORTS to control inflation and promote economic growth are a bit like a diet or exercise program. It takes awhile to see the results rippling through the economy.

Still, there is one large group of Americans who’ve been stung almost every month by the Fed’s steady ratcheting of interest rates: homeowners with adjustable-rate mortgages or home-equity loans.

When the Fed increases short-term rates by a quarter point, as it did 17 consecutive times from June 2004 to June 2006, the monthly payment on an ARM climbs too -- not necessarily in lock step, but enough to make a difference. As a result, home buyers who took out a one-year ARM in mid-2004 pay interest rates that are 40% higher today than in their first month.

This is one reason the Federal Reserve may be more preoccupied these days than it ever has been with housing prices. Real estate has always been an important slice of the U.S. economy, and housing costs are a major factor in the Fed’s favorite inflation gauge, the Consumer Price Index. But the linkage between real estate and other aspects of the economy, especially consumer spending, has never been more direct or immediate. Hence the Fed’s concern about a possible bursting of the bubble -- if there is indeed a bubble -- or the potential repercussions for the rest of the economy from a mere flattening of the market.

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For a decade, the combination of low interest rates and rising home values created a “wealth effect,” with homeowners ramping up spending based on the real or expected equity in their homes. The spending boosted economic growth, although it also added to inflationary pressure.

The Fed has limited influence over this dynamic, other than to push up the cost of adjustable-rate mortgages. Often, housing markets have risen or fallen with the local economy, independent of the Fed’s actions on short-term rates.

On Tuesday, the Fed finally took a breather in its rate-hike efforts, leaving the target for short-term rates at 5.25%. Although core inflation rates are higher than Fed Chairman Ben S. Bernanke would like, the economy isn’t growing as fast as before -- in part because the housing market has gradually cooled.

More evidence of a housing slowdown arrived in the days after the Fed’s announcement, including reports of prices flattening in San Diego and Los Angeles. The bubble may not be popping, but the steam may be seeping out of it, which would make Bernanke happy. So long, that is, as a flat real estate market doesn’t trigger a recession throughout the economy.

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