The control of bank owned properties most certainly plays a role in inflating real estate values. By controlling the supply of REO's, the banks are able to get a higher price than they would if ALL of the REO's were released at once. If the banks released the entire supply, the inventory of homes on the market would create a larger disparity from demand, which would drive prices down. The laws of supply and demand are quite simple. If supply increases and demand stays constant, prices must go down for market equilibrium. Releasing the shadow inventory on the market and lowering the price most likely would increase demand and could actually increase prices. The market we see today is not a true free market. There are controls set in place.

The main driver of inflated values however are the ultra low interest rates. You really have to look at the data BEFORE the Fed began buying mortgages. Price and sales decline were at their lows in '07 and '08. The demise of AIG, Merrill Lynch, and Lehman Brothers prompted the Fed to intervene. Part of their intervention was the MBS Purchase Program, where they allocated $1.25 TRILLION towards new mortgages. The Fed had cut rates in hopes to lower mortgage rates, but it did not happen with private capital. The spread between Treasuries and Mortgage Backed Securities was at an all time high. Investors demanded a higher return. As we near the end of the program, it will be interesting to see what happens with prices. Coupled with the expiration of the homebuyer tax credit, we could soon see the continuation from '07 and '08.

The real questions should be, how high will rates go when the Fed stops buying mortgages? Who will step in their place to purchase these mortgages? If rates go up, will that further pressure prices downward? And if so, how much? If the banks continue releasing REO's slowly onto the market, how much longer do we have to go before the books are cleared? If foreclosures have increased year over year since the crisis began, how much longer until we see a year over year decline? How can sales and prices continue to go up if delinquencies and foreclosures also go up?

Frank,

Good comment and I agree with just about everything you said with the exception of "Releasing the shadow inventory on the market and lowering the price most likely would increase demand and could actually increase prices." I'm not going to turn this into an introductory micro course here so I'm going to simply say you're wrong, go back and review one of your textbooks or study guides.

I too am very curious to see what happens to mortgage rates and home prices when the subsidy program ends at the end of this month. One real possibility however is that while it may technically end, functionally speaking, it may not end. The program has been the Fed monetizing mortgages, but what if they simply monetized treasuries given that the US Treasury now explicitly backs Fannie and Freddie?

Given the Fed's exit strategy of keeping newly created money in the hands of banks and out of the hands of everyone else, it seems that the unprecedented, unthinkable, but highly creative is the new norm. Given that, if I swore I was going to end an MBS purchase program at the end of March, but still wanted to keep rates low without blowing my credibility I'd funnel the same money to the same end source through the US Treasury as an intermediary.

I am a homeowner and I think that prices will go up when mortgage rates go up. I also believe that buyers who haven't bought a new home yet are pretty crazy. I have raised the asking price for my home accordingly. Everyone needs a house. With the tax breaks and credits - if you want to trade up, now is the best time to do it. I checked with my realtor and he says contracts are being signed all over the place. My mortgage broker has approved me for a very large loan and says loans will get bigger in the future which means housing prices will keep going up for a long time.

Love your dry wit, Paul. Good luck with that higher asking price. ;-)