Economic Analyst and District Liaison, Federal Reserve Bank of Philadelphia

Melinda Young

As published in Scotsman Guide's Residential Edition, October 2006.

Most readers likely are familiar with the Federal Reserve. How the Fed impacts the mortgage industry, though, might not always be clear. James Gillard of the Federal Reserve Bank of Philadelphia explains.

What does the Federal Reserve do, and why should mortgage brokers pay attention? The Federal Reserve system has three main roles -- to conduct monetary policy; to supervise, regulate and examine the banking industry; and to provide payment services to the banking system.

As the monetary-policy-making body of the U.S. government, we have a dual mandate -- to promote maximum, sustainable economic growth and to ensure price stability. The Federal Reserve sets the target rate for the federal funds rate -- the rate that banks charge other banks. This feeds into other important rates, including the prime rate and the mortgage rate, which have a significant impact on the housing market.

Some economists believe that many homeowners are counting on the appreciation in their homes to substitute for personal savings. What are the implications? We call it the "wealth effect" -- when people feel wealthy, they're more willing to spend. Families who purchased their house five years ago for $200,000 and who know that it is today worth $300,000 feel wealthy. Therefore, they spend more and save less because they believe their house is doing the savings for them.

The concern is that the wealth effect works in the other direction. If home prices decline, people feel less wealthy and spend less. This is a concern for the overall economy.

What do you make of talk of a housing bubble? In some locations, such as California and Florida, there's a risk of local bubbles because prices have been driven above where fundamentals such as income and interest rates suggest they should be. For the nation overall, though, I don't expect to see large downward adjustments.

What impacts do you foresee alternative-mortgage products having on the economy? People often speak of these innovations in a negative way, but I think they have had a positive effect on the economy. They have increased the number of households that can purchase a home. Higher levels of homeownership can convey many positive benefits to neighborhoods and families.

How do you respond to general rumblings about rate hikes implemented by the Fed? Inflation is the great enemy of the economy. Policy-makers have to remain vigilant about fighting it. One thing we've learned in the past 50 years is that once inflation gets out of control, it's costly and painful to combat.

Melinda Young is an associate editor at Scotsman Guide. Reach her at (800) 297-6061 or melinda@scotsmanguide.com.