The run-up in U.S. real estate prices could potentially amplify any future economic downturn, a Federal Reserve official said on Tuesday, urging regulators globally to consider tools beyond interest rates that could help cool the sector.
A sharp downturn in U.S. residential and commercial property prices in 2007 and 2008 rocked banks that were highly leveraged in the sector, sparking the global financial crisis and deep recession. With the economic recovery now well under way, bank holdings of commercial and apartment mortgages rose 9 percent and 12 percent, respectively, in the past year.
Eric Rosengren, president of the Boston Fed and an influential financial regulator at the U.S. central bank, said the "sharp" rise in apartment prices in particular may signal financial instabilities that interest rates, which are only gradually rising, may not be able to contain.
"Because real estate holdings are widespread, and the monetary and macro-prudential tools for handling valuation concerns are somewhat limited, I believe we must acknowledge that the commercial real estate sector has the potential to amplify whatever problems may emerge when we at some point face an economic downturn," Rosengren said in prepared remarks for delivery to a banking supervision conference in Bali, Indonesia.
He noted that real estate has repeatedly played a big role in episodes of financial instability, and that prices are now outpacing growth in building owners' operating income.
Since equilibrium interest rates — the Fed's traditional tool to guide the economy — could remain lower than decades past, Rosengren said, "this would require a greater emphasis on macro-prudential tools if valuations became a source of concern."
Such tools include rules and restrictions on bank holdings. "It is prudent to keep a healthy, ongoing focus on the sufficiency of these tools and their ongoing enhancement," he added.