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Old 10-12-2008, 02:16 PM
Location: West, Southwest, East & Northeast
3,446 posts, read 6,432,846 times
Reputation: 866


During the huge increase we have seen in housing prices over the past years interest rates (cost of consumer credit if you will) "should have" moved up to 10%-15% (or higher) to find an equilibrium for [house] values versus the cost of consumer credit to buy [houses], however our friendly (and very stupid) government kept rates artificially way too low, which prevented equilibrium being sought. Therefore we had runaway [housing] values because consumer credit was too cheap. If the Fed goes back to using sound economic principles (what is correct and proven to work in the past) in the future this won't happen in the foreseeable future again. In the meantime [house] values will continue to decrease until they find a value level where they "should have been" if the Fed had done it correctly in the first place.

Basically, housing starts is one of the leading economic indicators. A higher-than-expected increase in housing starts triggers economic growth and is considered inflationary, causing bond prices to fall and yields and interest rates to rise. Likewise, decline or declining trend in housing activity slows the economy and can push it into a recession, causing yields and interest rates to fall. That said, when housing starts were very high the value of houses continued to increase, but instead of interest rates rising to offset inflation they remained [artificially] too low. Throw in a heavy dose of easy credit and 100% financing along with a Fed mandate (thanks to Barney Frank and his many Dem buddies) to easily put high-risk people in houses (many of which couldn't even afford to own a house) and it was just a matter of time before everything fell apart and came tumbling down. That is exactly what must continue to happen (house values tumbling down) and finding a level of true value before things can ever get turned around and start operating correctly.

If the Fed uses smoke and mirrors to keep house values propped up higher than what they really should be, they have not corrected the situation...and we will face yet another implosion sooner rather than later.

Look at the last two graphs/charts -- note that the 30 year fixed non-jumbo (that is, the cheapest possible mortgage) approached 15% interest rate in the late 1970s through the mid-1980s. I think the mortgage rate will soon get back to 10-15% (instead of 5-7% like the last six years). As an aside, homes became so expensive over the last few years as any purchaser could borrow cheaply -- too much cash chasing the same number of homes created excessive appreciation. As the mortgage rates go back to 10-15% (the real fair market value taking into account the risk of lending for the purchase of a home and the chance of inflation), that will, of course, drive down the cost of homes as fewer buyers can afford to spend (borrow) as much. And of course, non-government backed jumbo mortgages will be priced several percentage points higher (even more lending risk, more inflation risk, not sellable to the government, not government backed) meaning there will be even more contraction in the upper end homes.

The figure that matters to most people, of course, is the financing-affected cost of a house. You are not just paying the cost of the house, but the cost of the house plus the cost of the financing to purchase the house. If the price of the house goes down (good) but the price of the financing goes up even more (bad), then the financing-affected cost of the house is actually worse. Your goal (like a private equity shopper looking for the next company to buy with 80% borrowed money) is to find the bottom of the market, taking into account both house prices and mortgage rates.

To put it in simple terms - if house values are too high then interest rates should move higher (causing people not to be able to afford and buy houses) which brings the values back down and in-line with where they should be. Likewise, if house values are too low then interest rates should move lower (creating higher demand for people to be able to afford and buy houses) which causes house values to rise. The optimum is when equilibrium is reached and maintained in a narrow window.

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Old 10-12-2008, 07:02 PM
1,476 posts, read 4,021,653 times
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Kooter great post, makes sense to me.
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Old 10-12-2008, 09:14 PM
Location: Yardley PA
689 posts, read 1,990,372 times
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Great post.
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Old 10-13-2008, 11:53 AM
Location: Eastern Long Island
1,280 posts, read 4,162,833 times
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very true, some people think Alan Greenspan is a genius, others think he's the devil.
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Old 10-14-2008, 09:24 AM
Location: Orlando FL
1,065 posts, read 3,663,222 times
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I don't know, I can see your points on many things...higher cost to borrow = lower affordability = less home buying = less appreciation or depreciation of housing. I get that, but even with "artificially" low interest rates, housing prices still got out of touch with what people could afford thanks to the geniuses on wall street creating all those new "investment vehicles" and weird mortgages.

And while your chart seems to point to some kind of a relationship of prime rate and mortgage rates, there are no direct correlations. There was simply alot of money chasing after those mortgage backed securities that kept rates low....the fed doesn't control mortgage rates. I"d blame it more on the wall street salesmen doing too good of a job convincing investors all over the world that MBS were the safest bets around, world money went into that one area and that is what kept the rates low there, not the fed funds rate. Money kept flowing into MBS because money kept being "created" via 40 to 1 leverage of large un-regulated investors that could do it. The fed rate just dropped .5% and mortgage rates are UP .5% now.

Plus it can be argued that the fed really only changes TARGET rates when the markets demand it. IE their target rate is 2% but the markets are indicating they are trading on 1.75% so a .25% rate cut is on the table, and visa versa.

But what do I know, I'm just a realtor that watches too much CNBC and spends too much time on this forum
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Old 10-14-2008, 12:10 PM
878 posts, read 1,840,440 times
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I'm no mortgage expert, but it seems to me that there's a "threshhold" level of monthly payment for home owners. By way of example only, a homeowner might expect to pay about 25% (say $1000) of his income every month to buy a home.

The homeowner doesn't care how much of that is principle and how much is interest, just that he pays a certain rate. If rates are higher, prices fall, and the consumer pays (e.g.) $500 interest, $500 principle. If rates are lower, prices rise, and the consumer pays $250 interest, $750 principle.

To the homeowner who stays in his house for 30 years, or always buys an equivalent home, interest rates and home prices have little to no effect on him.

The lending institutions are receiving a better rate of return, they are making a lot of money off of homeowners.

Likewise, wealthy investors who can pay cash for real estate are able to acquire more property, because of deflated prices.

Lower interest rates, and higher prices, benefit the mortgage holders. More of each payment goes towards principle, so they build equity faster. Homeowners are able to use a small percentage to get credit, leaving the remainder to invest in other avenues which might provide a better return.

Seems to me that higher interest rates are best for people who have lots of capital, while lower rates are best for those who rely on income .
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Old 10-19-2008, 11:14 PM
Location: Cary, NC
1,036 posts, read 3,619,215 times
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Well, the FED under Greenspan and at other times had said that they do not move rates in order to influence the stock market and prices of investments. The same probably applies to home prices and the real estate market.

They shift rates to account for economic conditions such as growth and inflation, but they do not really look at housing prices and the measurements you mentioned. Housing is an indicator and is factored... but they were more worried on the crashing market, liquidity issues and other problems a few years ago and kept rates too low too long with little regulation for what lenders did with that money.

Its not just the capital injected into the market that was the problem, its the risks lenders choose to take with the easy money they had access to. Now the government and FED are pumping liquidity back into the market... but is more easy credit and another potential bubble really a good solution?
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