tag:blogger.com,1999:blog-1110014885778996459.post51782032760823814..comments2024-03-29T04:50:03.060-07:00Comments on Idiosyncratic Whisk: Real Interest Rates & the Housing BoomKevin Erdmannhttp://www.blogger.com/profile/07431566729667544886noreply@blogger.comBlogger4125tag:blogger.com,1999:blog-1110014885778996459.post-84427436315222406412013-10-29T14:17:38.414-07:002013-10-29T14:17:38.414-07:00That's a great point. These aren't the on...That's a great point. These aren't the only two factors involved. The research Tyler Cowen linked to in my next post considers bank credit market conditions. I think, for the period from about 1970 to 2007, real and nominal rates can explain a lot of home price movement. After 2007, I think the crisis in the credit markets becomes the bottleneck factor that is preventing demand from bidding home prices up to fundamentally justifiable levels. Calculated Risk has documented how much of the buying activity is from all-cash private equity investors.<br />Just as the rise of home prices in the late 1970's in the face of double digit nominal rates is a sign of the power of real rates in driving home prices, I think the current rise in prices that is happening while credit markets are still very tight also shows that power. As the recovery continues and the banks re-capitalize, home prices should continue to increase, depending on how high real interest rates rise into the recovery.<br />What I am afraid of is the Fed reading that as a bubble and taking unnecessary actions to pull back the economy.Kevin Erdmannhttps://www.blogger.com/profile/07431566729667544886noreply@blogger.comtag:blogger.com,1999:blog-1110014885778996459.post-7598278239926410942013-10-29T13:29:51.928-07:002013-10-29T13:29:51.928-07:00Thanks for the reply. Just continuing on your poin...Thanks for the reply. Just continuing on your point #1, I see your plot of real interest rates vs (I assume inflation adjusted) housing values in your next post. Although I agree with the theoretical basis for the inverse relationship between the two, empirically I have never been able to replicate it very well. Using real interest rates from FRED and a well-known HPA index, the plot during the 70's hangs out in the lower left hand corner, as you would predict based on the high inflation of the time, then moves to the right at real rates shoot up in the early 80's, then back down to around 3% as housing values bounce around, until real rates drop to ~2% in the 00's and HPA flys up asymptotically, again, as your model describes. But as real rates drop down to almost nothing, and inflation also goes to almost nothing in 2010-today, shouldn't house values continue to climb asymptotically? Instead, they shift back down onto a high inflation line, which doesn't seem to make sense.Nickhttp://mynotes.wsnoreply@blogger.comtag:blogger.com,1999:blog-1110014885778996459.post-41869458497042504212013-10-28T14:21:27.895-07:002013-10-28T14:21:27.895-07:00Thanks for your input, Nick. It is difficult to b...Thanks for your input, Nick. It is difficult to believe, and there are a lot of subtle things going on here. I'll just bulletpoint some possible clarifications:<br />1) The trigger for fundamental changes in home prices is the long term real (aka: inflation adjusted) interest rate, which isn't really reflective of monetary policy. It's just a reflection of a complex web of economic factors.<br />2) Where monetary policy came into play was that inflation premiums on long term rates were also really low, which, pretty much by definition, is the market expectation of long term monetary policy. This allowed home prices to adjust to their fundamental level. In the 1970's, when real rates had previously justified high home prices, prices couldn't adjust because high nominal rates (due to a high inflation premium) served as an artificial barrier to demand.<br />3) In the service of building a narrative, I probably make the bubble issue too much of an either/or issue. First, I think it should be clear that in reasonably functioning markets in ultra-low rate environments like we had, we should expect forces to naturally adjust to match new buyers to mortgages, which would include lower down payments and other mechanisms. Normally, banks would push back against this adjustment in a market where nominal home prices could decline. Because there was a banking bubble, this feedback was not as strong as it should have been. So, there could have been a little bit of bubbliness in the housing market, and it was made much worse by the banking bubble. By showing that home prices at the time could be justified financially and that they are rising again without any assistance from banking, I am attempting to argue that two separate issues are being conflated here, to the detriment of our understanding of the housing market. First, there have been large, but justifiable, fluctuations in the prices of homes. Separately, a banking bubble happened to use housing as an input, with some feedback coming back into the housing market as a result.<br />I don't mean to excuse every deal done by every mortgage broker, but to say that, in general, there was nothing unsustainable about home prices as we experienced them. They were more volatile than we were used to because the lack of qualification barriers meant that they could move more freely like bond prices, but it is implausible to expect most observers to immediately adjust their heuristics relating to the housing markets to account for this paradigm shift. But, I believe that if we don't account for that shift, we will badly misinterpret these market phenomena.<br /><br />I don't know if I'm addressing your question clearly or not. I hope that helps.Kevin Erdmannhttps://www.blogger.com/profile/07431566729667544886noreply@blogger.comtag:blogger.com,1999:blog-1110014885778996459.post-19163639668545291852013-10-28T13:00:03.615-07:002013-10-28T13:00:03.615-07:00I'm a big fan of Scott Sumner but I found your...I'm a big fan of Scott Sumner but I found your explanation difficult to believe. Although normally there is a trade-off between down payment and monthly costs, what we saw from 2004-2007 (I will refrain from calling it either a housing "bubble" or "boom" to avoid loaded terms) was a reduction in *both* the required down payment as well as the monthly payment. How can this be? First, the rise in the "affordability" products such as hybrid ARMs, IO's, neg am, and extended term loans reduced the monthly payments without requiring higher down payments. Second, the lower underwriting standards led to low doc and no doc loans that offered mortgages to people by qualifying them at rates that they would not have been able to obtain had they been required to submit actual income verification. <br /><br />I'm not sure how monetary policy (either tight or loose) led to either of these consequences. But the whole market monetarism school seems to be on the mark for so much, maybe there is an explanation that merely escapes me for now. Thoughts?Nickhttp://mynotes.wsnoreply@blogger.com