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We doubt that any single or simple story can explain the movement in house prices, especially over the past decade. While our analysis indicates that one plausible explanation of that boom, easy credit conditions – and low interest rates alone – cannot account for most of what happened to prices, we are not able to offer a compelling alternative hypothesis.
What a joke. They cannot see what interest rates did and they cannot offer an alternative hypothesis either? Seriously? Consider the following chart.
May 3, 2009
Housing Price Simulation
I used a very simplistic "What do you want your monthly payments to be" computer model. Does that not do an adequate job of explaining what happened? The chart shows what happens when wages rise (in nominal terms). That allows housing prices to rise. It also shows what happens when interest rates fall. That also allows housing prices to rise, since lower rates lead to lower monthly payments. It's a two-fer!
How can anyone possibly think that falling interest rates were not the primary factor in creating the housing boom? The #1 reason I turned bearish in 2004 is because I was receiving ZERO PERCENT mortgage offers in the mail. Why can't some economists figure that out? Are they locked away safely within their ivory towers?
So what went wrong? Let me repeat what I said in 2009.
It is a "what do you want your payments to be" problem. Since housing prices were rising faster than overall inflation, housing prices were also rising faster than the cost to build the homes. Thanks to capitalism, that meant that more and more homes would be built. Eventually, there were just too many homes and everyone started to realize it. Oops! At that point, it stopped being a "what do you want your payments to be" problem and became a "how do I unload my home before it tanks to its true value" problem, or should have been anyway.
Need more proof? Let's see if we can spot "more and more homes" being built. Yes. There they are in the following chart being built and being sold. That's twice as many as is typical. Oops!
August 28, 2010
George Soros vs. Jeremy Siegel
How hard is this to understand? Just look at the feeding frenzy that falling interest rates created. Many economists can't even seem to figure it out in hindsight though.
December 14, 2004
Minutes of the Federal Open Market Committee
Some participants believed that the prolonged period of policy accommodation had generated a significant degree of liquidity that might be contributing to signs of potentially excessive risk-taking in financial markets evidenced by quite narrow credit spreads, a pickup in initial public offerings, an upturn in mergers and acquisition activity, and anecdotal reports that speculative demands were becoming apparent in the markets for single-family homes and condominiums.
Duh!!
The only economics class I have ever taken was Economics 101 in college. It was the most skipped class in all of my college experience. I only showed up once a week to take the simple test. No joke. Apparently I did not miss much.
You may think I'm being too hard on economists. I don't think I am. If you ask two physicists where a cannon ball will hit based on the initial force of the explosion and the angle of inclination of the cannon, most would probably come up with a rather decent estimate. Physics is funny that way.
In sharp contrast, we still can't get all the economists to agree that falling interest rates were a major factor in the housing boom, even though the Fed itself saw the same risks I did in 2004.
22 comments:
It helps if you remember that in the 19th century, economics and political science were one field, called political economy.
People don't listen well to truths that puncture their cherished illusions.
Who Struck John,
People don't listen well to truths that puncture their cherished illusions.
Thanks for posting your thoughts on this. I'm having one of those days.
I posted a link to this post in the comments at Calculated Risk and got back...
The conclusions seem unwarranted- its like that asshole Kruggles and the idiot Christine Romer and their belief in their "model"...
It has always been my goal to offer the world's dumbest asshole opinions. I'm making fantastic progress so far! ;)
Live by the heckle, die by the heckle. All is fair in the blogosphere.
The most merciful thing in the world, I think, is the inability of the human mind to correlate all its contents. We live on a placid island of ignorance in the midst of black seas of infinity, and it was not meant that we should voyage far. The sciences, each straining in its own direction, have hitherto harmed us little; but some day the piecing together of dissociated knowledge will open up such terrifying vistas of reality, and of our frightful position therein, that we shall either go mad from the revelation or flee from the deadly light into the peace and safety of a new dark age. - H.P. Lovecraft (1926)
He managed to sneak that one in just in time for The Great Depression.
^ beautiful quote.
As for the how-much-a-month, other factors were the Bush tax cuts (and child credit -- $1000 for each kid could pay for $60,000 more house for families with 3 kids), and also the rise of teaser rate, interest-only, negative-am (aka suicide lending) reducing the effective interest rate, plus also the back-end DTI limits being evaded by the acceptance of liar loans.
Absent regulation and rational underwriting, prices were being set on the margin of what the greater fool would pay.
This wasn't evident to me until the Casey Serin story broke in late 2006. After that I knew he was just the first cockroach and the whole thing was coming down.
btw, there's one argument that the entire neo-classical school is a fraud . . .
http://homepage.ntlworld.com/janusg/coe/cofe00.htm
Those who confuse land with capital will confuse rising land value with rising wealth.
The opposite is the case, of course. Rising land values impoverish us. Well, most of us, as the landowners of course make out like Zuckermans.
Economics is not a real science thats for sure.
Troy,
the rise of teaser rate, interest-only, negative-am (aka suicide lending) reducing the effective interest rate
Indeed. My simplistic "what do you want your payments to be" computer model would be more than a bit confused by teaser rates.
Rising land values impoverish us.
I often wonder if/when China will figure that out.
GYSC,
The Onion: Bush Defends Deny-Side Economics
Well, Bush did have to abandon his free market belief in order to save it after all? I remember that line and thought is perfecty apt for our times.
GYSC,
It's okay. Bush also had to embrace the use of state-sponsored torture in order to save us from those who might wish to terrorize us.
Bush's Glib Waterboarding Admission Sparks Outrage
George W. Bush's casual acknowledgment Wednesday that he had Khalid Sheikh Mohammed waterboarded -- and would do it again -- has horrified some former military and intelligence officials who argue that the former president doesn't seem to understand the gravity of what he is admitting.
United Nations Convention Against Torture
Oh look. There we are in the list. Go figure. It's apparently a "criminal offence" and no circumstances can be used "to justify torture, including war, threat of war, internal political instability, public emergency, terrorist acts, violent crime, or any form of armed conflict."
Welcome to the freedom and capitalism loving United States of Hypocrisy.
Indeded. I am for once unable to add, unreal.
"Rising land values impoverish us.
I often wonder if/when China will figure that out."
Since the government owns the land and the official can personally profit from it, not much chance.
The "how much can you pay per month" model applies in other countries as well. In China, though a lot of sales are done for cash - which you would think would discourage low interest rates from translating into higher prices. I guess their bubble has a different dynamic.
If the US went back to 20% down payments, I would guess that would also put a damper on house prices. I am amazed that that has not really happened yet.
Coba
A little semi-serious devil's advocate here:
The tulip bubble in Holland...was that due to low interest rates, too? Or was it a sort of mania? Perhaps housing was like that and the low interest rates merely acted as an accelerant.
Also, low interest rates do not make lenders hand out mortgages to one and all, without even checking their salary. Securitization allowing the selling on of risk, does allow that to happen. Stupid German cities buying MBS to chase yield leads to no-doc loans in California to fruit pickers. This creates much more "demand" than there would normally be without securitization and thus leads to rising house prices for a while, until the model broke.
I have another quasi-theory too. Low interest rates could have inspired more investment in factories in the USA rather than houses. Why didn't that happen? (or did it?) Because you open factories in China not the USA. Thus the available money in the US is mal-invested more into the one area of the US economy that does not compete with China and India: housing and restaurants...More money chasing a single sector = price increase in that sector.
Mark,
I've said it once and I'll say it again, your charts are awesome.
Thanks.
Coba,
"If the US went back to 20% down payments, I would guess that would also put a damper on house prices. I am amazed that that has not really happened yet."
I absolutely agree. In 1997, it was up to me to decide how much loan I wanted as long as I put 20% down. I had $55k and ended up in a $275k house. Not a coincidence.
"Perhaps housing was like that and the low interest rates merely acted as an accelerant."
I agree with that.
How much house can you afford?
Note that the calculator is a based on a "what do you want your payments to be" model. Try plugging in 8% vs. 5% as the mortgage rate. Gasoline on tumbleweeds. Accelerant!
I'm also a believer in your "quasi-theory".
watchtower,
I never tire of your "awesome" commentary. I might be just a tad biased though, lol. ;)
"If the US went back to 20% down payments..": I can't speak for the US, but the Bank of England is thinking out loud about doing just that.
http://www.telegraph.co.uk/finance/personalfinance/borrowing/mortgages/7971097/Bank-plans-to-cap-risky-mortgages.html
dearieme,
From your link...
The suggestion of a cap on lending alarmed mortgage experts who said they feared that the rationing of home loans would stop first-time buyers getting on to the housing ladder.
I bet it did. If memory serves, these mortgage experts often earn a commission on each sale.
Very few first-time buyers can afford a big deposit so its important that they are not excluded.
Spoken as a completely unbiased mortgage broker of course.
As for the how-much-a-month, other factors were the Bush tax cuts (and child credit -- $1000 for each kid could pay for $60,000 more house for families with 3 kids)
This reminds me, has anyone stopped to figure out how much more expensive kids are to the middle-class compared to the under-class?
A fellow I loosely know is on food stamps. He has two kids, his wife doesn't work and he is unemployed. His food stamp allowance is over $750 a month. The kids get free healthcare through SCHIP. When his wife is pregnant so does she. The "work" requirement for food stamps (actually it's "look" for work, and please don't make me explain what little is meant by looking) has an exception for adults taking care of children less than 6. One child, one adult excepted. Two child, two adults excepted. School lunches and about every other school fee you can imagine is automatically waived if you show your food stamp card. Day care is free through head-start. Throw-in the section 8 voucher and there's not much left he has to pay for, or worry about.
Contrast that with the middle class guy. He's gotta worry about what groceries really cost. What health insurance really costs. How well the kids of the neighbors he can afford are behaved (with kids, you're not buying a house your buying the kids your kids will go to school with). All that in the face of overseas out-sourcing in manufacturing and domestic out-sourcing in labor; which is to say stagnant wages for a generation.
So what do we have? Among those with any kind of future time orientation: less and less children. Among those in which life is something that happens *to* one: rampant illegitimacy and no chance of being able to pay-as-their-grandparents and soon now parents-go in Social Security and Medicare.
But, hey, those child-tax credits that phase out around $120k anyway are an outrageous give-away. (Note I'm not picking on anyone here, just that they are generally complained about.)
"A fellow I loosely know is on food stamps. He has two kids, his wife doesn't work and he is unemployed. His food stamp allowance is over $750 a month. The kids get free healthcare through SCHIP. When his wife is pregnant so does she. The "work" requirement for food stamps (actually it's "look" for work, and please don't make me explain what little is meant by looking) has an exception for adults taking care of children less than 6. One child, one adult excepted. Two child, two adults excepted. School lunches and about every other school fee you can imagine is automatically waived if you show your food stamp card. Day care is free through head-start. Throw-in the section 8 voucher and there's not much left he has to pay for, or worry about."
My wife attends and ESL school. Some of her classmates were shocked we were not on food stamps, section 8 housing, etc. They even helpfully explained to her how to get around some of the asset checks.
I actually went to the sites and decided I could figure out ways to use the system as your fellow does. Its pays better than honest work. Oh, and you could even work a few months a year to get the earned income tax credit too.
AllanF & Anonymous,
So what do we have? Among those with any kind of future time orientation: less and less children.
I hear that. I'm all about the future time orientation. I don't plan on having children. At least part of it is because we as a society keep placing all of our burdens on our unborn children. They are supposedly going to be the ones to pay for all that we've borrowed.
There's a part of me that thinks I was born in Peak America. I've got enough to worry about without having to think how my children would do.
Japan's financial difficulties have lasted 20+ years. One would think their birthrate is declining for good reason.
In Europe, where the safety net is awesome, birth rates decline too.
Of course, I am a revert to the mean kind of guy too, so eventually, the women left will be those who like children and we will have more children.
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