It remains immensely foolish to buy a house: Part 1
In part one of our series on the lunacy of buying into real estate, we consider the interest rate argument. Home mortgage rates are not only at cyclical lows, but at all time lows. Some banks are offering 30 year fixed rates at 4.375% as of January 4, 2010. Now’s the best time ever to buy, right?
Banks, buttressed by the Federal Reserve and Obama administration, are using the well known bond price:yield formula to skewer the public. Too many Americans have faith in their government’s stability measures and little understanding of basic finance. This combination leads to a fatal misunderstanding of the real estate market.
Let’s walk through how ridiculous the “rates have never been lower” argument is. We’ll use the 30 year US treasury as an example since most home loans have about the same term. Here’s a chart of the yield on the 30 year treasury since 1977.
For 30 years, treasury yields have fallen as asset values have risen. Can yields drop any lower?
Treasury bond prices are very similar to home loans. When interest rates are high, as they were in 1980, the price of these bonds is quite low. No one wants to hold these bonds because they expect rates will go higher still. The bonds sell at a discount to their face value. The government hates issuing debt at rates this high because it must make interest payments at these extremely high yields. The opposite is true when rates are low. The government loves issuing more debt because the cost of servicing these debts is so low.
Consider now the consequence of progressively lower bond yields as shown in the figure above. As the 30 year treasury falls, the price of bonds rise. Similarly, when mortgage rates fall, the underlying asset (home prices) increases in value. Banks love it when mortgage rates are low because the principal is higher. Banks also like occasional foreclosures (as opposed to the mass foreclosures we see now) because after they seize the home, they can resell that home for the same or higher price. Banks always win with sporadic foreclosures; the population wins with mass foreclosures. Just imagine the effect on US bond prices if China dumped all their US denominated treasuries on the market.
For 30 years, Americans have witnessed a steady fall in interest rates with an initially slow (followed by a rapid) rise in home prices. But in 2008, something interesting happened: interest rates collapsed. The 30 year bond could conceivably fall to zero still, but it’s highly unlikely. How could anyone possibly bet on zero inflation over 30 years in the United States?
So, there are only 2 realistic possibilities with interest rates at this time. First, they could rise with an inflationary monetary policy, which would drive home prices down. Or they could remain low for years signaling Japanese style deflation, which would also drive home prices lower.
But too many Americans are simpletons in regard to interest rates. Let us spell it out more clearly: if interest rates rise, nominal home prices may remain steady or even increase; the real price will fall. If interest rates stay low, both nominal and real prices will fall. Yet another reason simple Americans should root for deflation. It’s just easier for all of us to understand.
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The way I see it, a lack of regulation and oversight caused the housing crisis. Not interest rate policy. The Federal Reserve is always right. Listen to my speeches. We’re always right. Without the Federal Reserve, the country would be worse off. And if we’re ever audited, then you’ll get hyperinflation. You’re stuck with us forever now. Don’t even try to question us.
BTW, Alan Greenspan got it right too.
I agree, even where I live small town midwest America, home prices are going lower, if even a a slower pace than the coasts. No upturn in sight.
don
spiritnewsdaily.com
I’m currently doing a little investigative research studying bills, notes, and bonds. It’s a big subject.
To say the least, it’s not easy grasping how things work. From my understanding, though, mortgage rates are generally connected to the 10-year NOTE. That’s what I’ve read. This is a note not a bond. And a note is not a bill. And a bill is not a bond.
In your example, you’re connecting mortgage rates to 30-year bonds. That may not be totally correct?
In addition, 30-year bonds were only re-issued in 2006. So for a period of time, 30-year bonds weren’t even around. I do know 30-year bonds were around in the mid-’80s. That’s when yields were like 15 percent. Or even a little more. I don’t know the year they vanished. But they did vanish. Probably because the government was paying 15 percent yields.
I’ve read about 100-year bonds. I’m in the dark about those.
Economics, and all its manifestations, is not an exact science. When you try to simply things, you may get into trouble. There’s always twists and turns that may be similiar to earlier events but only similar. Not exactly identical.
I agree witht he author, especially in states like California, Nevada and Arizona where prices will continue to fall sharply. Look at the trend, I see prices dropping another 10+ percent in the year 2010.
Sources: http://wwww.homepricetrend.com
It remains immensely foolish to buy a house – American Compass…
In part one of our series on the lunacy of buying into real estate, we consider the interest rate argument. Home mortgage rates are not only at cyclical lows, but at all time lows. Some banks are offering 30 year fixed rates at 4.375% as of January 4, …
My mother bought her house in 1989 in brooklyn, NY
for $265,000. Today, even after the recent fall in price,
it is worth about $900,000.
According to the inflation calculator, $265,000 in 1989 is equivalent to $454,512 today. So what happened? Are the government’s
CPI figures skewed? How come the house has appreciated in value so much? After all , Robert Shiller claims that house prices appreciate over time at the same rate as inflation.
Part of the reason for the price appreciation is that neighborhood has gotten gentrified and many people want to live there now.
But the main reason for the price appreciation is the fall in interest rates from the then 10.25 percent to today’s low rates.
Here is the math: if today mortgage rates were to rise back to
their 1989 level of 10.25 percent, then the value of my mother’s house would have to fall 40 percent in order to service the mortgage
with the same monthly payment.
Now just hold on you whacked out commie
1. Every year since 1776 house prices have gone up 10%
2. Because of immigration there is incredible and growing demand for housing
3. Because of evil enviromentalists there is no land anywhere in the US to build new housing or even an addition to an existing house
4. Housing is your best investment no matter how much you lose
5. Nobody ever invested in housing. Each and every unit of a 10,000 unit condo development is occupied by its owner.
6. Unlike the stock market, nobody has ever speculated in housing
7. In ten years, house prices will rise so high that you will miss your chance to buy a home forever unless you get in RIGHT NOW
8. With nothing down and nothing to pay each month, the house of your dreams is uniquely affordable
I disagree, we’ve been waiting out the boom for years now. Prices are finally where we want them to be, and we’re tired of the doom and gloom. I’ve been reading these websites for years now. There wasn’t much house appreciation here and probably won’t be any depreciation, because of very few IO loans. I’m not stupid, I just want my house to live in and enjoy. I’ve waited long enough.
Hi Jan -
There are many other reasons to buy a house – good school district, get off the grid, tax shelter, live close to family and friends, live in the neighborhood of your dreams, or just tired of renting. In those cases, you might choose to pay a premium to buy. But policy makers should never have allowed a housing bubble for just those reasons. People have to buy food and shelter. Bubbles in those markets are most pernicious.
How come Larry Summers,the former head of Harvard University is
always reeled out to display his expertise on the economy when he lost Harvard 27 Billion in it’s endowment. Also how come Robert Rubin,former Treasury Secretary who along with Summers promoted deregulation with the repeal of Glass-Steagall and nearly destroyed Citigroup where he was a major “swell” is advising Obama? Is this the “change” the peasants expected when they voted for Obama?..more gangsters shuttled from Clinton to Bush and NOW Obama…wait till Spain,Ireland et al default and the commercial Real Estate sinks…is that when an attack will occur on Iran….its coming…
I thought he’d support the downtrodden ’cause they did not get a fair deal in life. Instead of doing anything for them, Mr Oba-freaking-ma is bailing out greedy people and artificially keeping the home prices high. This is not the CHANGE I wanted. Next time, my vote goes to the candidate I’d hate most. Probably he/she will make me feel better by throwing in a “surprise” bone at me.
Message for Mr. Oba-freaking-ma – Turn around the public school system and kick every Black’s ass to send their kids to school. Educate them. That’s the CHANGE I voted for! And yes, I’m colored.
“Message for Mr. Oba-freaking-ma – Turn around the public school system and kick every Black’s ass to send their kids to school. Educate them. That’s the CHANGE I voted for! And yes, I’m colored.”
Turn around the public school system? Give me a break. NO president will be able to do that in one term, by himself. What’s a good place to start? How about demanding more accountability from parents, many who probably aren’t qualified to be parents in the first place, to motivate their own kids? And if enough parents demand it, it will change. Instead, everyone just sits around complaining the current administration while watching the latest episode of American Idol. No president can do it alone. Expecting any administration to come up with a plan that will magically fix everything and that everyone will agree on is pointless – you’re better off waiting for the Easter Bunny.
I appreciate you observations, but tend to think housing, being a buy, is more of a local issue. In the areas that housing boomed, Florida, California, Arizona, and Nevada, prices may still fall significantly. In other areas that escaped the rising trends, like upstate NY, housing is more fairly valued.
So if you can get a low interest mortgage on a fairly priced house, you can do well. In still over priced areas, it’s not, as you point out. I recently moved to Florida and remain amazed at the glut of homes and retail properties on the market. There is nowhere to go but down here, despite much magical thinking otherwise. But back in NY, the situation is vastly different.
While I may have paid too much, I was still able to get a two years old home at half the original price on a short sale. It’s twice as large, in much better condition, and has lower taxes. It was priced the same as what my home in NY realized in a slow market. So in my case, it was a bargain.
Hi Jeff –
Please consider part 2 of our series from today. Certain markets are oversold right now (i.e. Detroit). Others never experienced a bubble in home values. Housing may be reasonable in those areas as an investment. The potential investment loss though still remains great.
Housing should never have become an investment vehicle in the first place. Bubbles are for financial markets. Housing can be fairly illiquid and too many people can get crushed when prices finally do tumble.
Its a credit bubble. Houses are bought on credit.
It’s not foolish to buy my house. I paid almost 2 million for a 3 bedroom house, so don’t worry it’s only really worth $750K. It will be worth more when I go to prison for Treason, you can charge admission to visit the house where America started to be ruled by us Crooks!
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Until we get past the 5 year ARMS established in 2005 and 2006 on houses that are now significantly underwater we should not expect real estate to be a good investment.
nice to see you on blog