A bad combination: Inflation rises as home prices fall

Back in the 1970s, the dreaded economic trend was "stagflation," which meant a stagnant economy coupled with rising inflation. By the early 1980s -- when mortgage interest rates were in the double digits -- the "misery index" became a new number to track, which combined unemployment rates plus inflation.

Inflation is really worse than recessions because its impact is much longer-lasting; to break its back in the early 1980s, then-Fed Chairman Paul Volcker continued to hike interest rates -- over 19% for federal funds in 1981 -- to tame inflation for the long term, although it seems that Reagan gets most of the credit for it (and all he did was re-appoint the guy in 1983) while Jimmy Carter got the blame. From a high of 13.5% in 1981, Volcker managed to lower it to 3.5% two years later. I don't think I could've done it any better myself!

Now it looks we need a new term: that of falling home prices (or deflation) and rising inflation for almost everything else (except for flat-screen TVs, which fortunately continue to get cheaper):

Two worrisome trends for the economy — falling house prices and the rising cost of everything else — picked up speed in data reported on Tuesday, putting policy makers in an increasingly tough position.

If they move too aggressively to cut interest rates and stimulate the economy, they might stoke inflation at a time when consumers are already squeezed by higher prices for food, energy, clothing and other goods. But if they choose more austere measures, the economy may weaken substantially faster...

A leading index of home prices in 20 cities fell by 9.1 percent in December from the same month a year ago. Using a three-month moving average, the index, the Standard & Poor’s Case-Shiller, is falling at an annual pace of more than 20 percent. The index tracks repeat sales of single-family homes; it does not include condominiums.

Another government index of home prices that covers more of the country but does not include loans above $417,000 fell 1.3 percent in the fourth quarter, after falling 0.3 percent in the third quarter. The index, compiled by the Office of Federal Housing Enterprise Oversight, showed prices declining in all states, except Maine.

The Labor Department reported that wholesale prices, which exclude taxes and distribution costs, rose 1 percent in January, up from a drop of 0.3 percent. Compared with a year ago, prices were up 7.4 percent. Excluding volatile food and energy prices, the index was up 2.3 percent from a year ago, up from 2 percent in December...

“February may go down in history as the month that the previously indefatigable U.S. consumer finally threw in the towel, beaten by a combination of deteriorating labor market conditions, surging prices for food and energy and collapsing house prices,” Paul Ashworth, a senior United States economist at Capital Economics, wrote in a note to clients.

The Fed has cut its benchmark interest rate to 3 percent, from 5.25 percent in September, in an effort to offset the drag from the housing market on the broader economy. Its efforts have helped reduce some of the strains in the financial market but they have been less successful in lowering borrowing costs and easing lending standards for businesses and consumers...

Economists say home prices will remain under pressure for much of the next year or longer because the supply of homes for sale remains high. It has also become harder for home buyers to get mortgages as rates have risen and banks have become more conservative in demanding bigger down payments and more proof of income than they did during the housing boom.

In many parts of the country, specialists note that home prices remain too high based on affordability calculations made using incomes and interest rates. A recent report by analysts at Credit Suisse, the investment bank, said that prices in some metropolitan areas like Phoenix, Miami and Los Angeles would have to decline by 20 percent to 40 percent more than they have already fallen for home affordability to be restored to its long-established level.

What they DON'T mention is that prices to rent have also escalated sharply over the past 5 and 10 years; certainly not at the same level that home prices did, but enough to make investment properties pencil out at a higher level than median incomes alone would indicate.