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Housing Woes

Okay, so we all know that the bursting of the housing bubble is one of the main catalysts of the current recession. Lenders got sloppy with their lending standards in an effort to make a quick buck on fees, home prices were bid up supporting lax lending standards (if the collateral to the loan – the home – appreciates really quickly, then a borrower with very little-to-no equity will all of a sudden have ample equity to support the loan), and people were leveraging themselves more and more by taking out loans against the equity they had in their homes. What no one saw coming was the fact that though borrowers may rapidly develop equity from home appreciation, if their incomes can’t support the low interest, adjustable rate mortgages when the rates go up, there will be mass defaulting, as we see today (and have seen for about two years now).

So, the metaphorical earthquake has already happened and we’re still watching the dust settle. The government is also trying to kick start the rebuilding, by kick starting the housing market. Home prices are down over 25% nationally from their high in fourth quarter of 2006 (see here for supporting stats). A lot of people have lost money in their homes as well as other investments (the S&P 500 is down about 45% from its high in October, 2007), and many others have lost their jobs. There is a glut of homes on the market, and no one wants to buy them for either: 1) not having the money or financial stability to support buying a home and paying a mortgage, or 2) persistent uncertainty about whether home prices have bottomed yet or not – after all, who wants to buy an asset that may still drop in value?

So, what does the government do to incentivize people to buy homes and try to turn this mammoth economy around? Well, first we drop the interest rate on mortgages to make home buying cheaper (it’s ironic how one of the main causes of the housing bubble itself was the availability of cheap credit and record low interest rates for too long a period, and that same thing is now the solution), and second we give people money (via the $8,000 tax creditfor first time home buyers) to make their decision to buy a home cheaper. Of these two solutions, I find the first - the artificial lowering of interest rates – to be the most worrisome. Though I understand that the government is trying to make borrowing cheaper so more people buy homes, I think it’ll have an unwanted side effect. Interest rates are at record lows now. Let’s suppose that Americans take advantage of this and buy homes (as the government hopes). This causes home sales to increase now, and for the economy to appear to be turning around. All is well and everyone is happy. Now, fast forward 10 years or so. Given that rates are at historical lows, they only have one direction to go from here – up. (Some argue that given all the financial stimulus the government has engaged in recently, they’ll have to inflate away some of the debt, causing rates to rise even faster than they otherwise would). So, ten years from now when the average American family goes to buy a new home, they’ll be faced with an unpleasant surprise: the rise in mortgage rates will be very prohibitive to buying a new home. Suppose they pay $100/month for their mortgage. Borrowing the same amount of money with higher rates will cause them to pay much more than $100/month. Couple that with their likely desire to move into a larger, more expensive home, and the whole proposition becomes very scary. Thus I would expect future home sales to fall relative to where they would have been had there not been such a large difference between the natural interest rate then and the artificially low rate now.

So, my conclusion  is that we may stimulate home purchases now by lowering rates to record lows, but this comes at the expense of housing sales in the future. So all we’re really doing is pushing the problem from now, into the future. Though that may be welcome for many right now, as investment portfolios are in tatters and many are unemployed, I would argue that if I have to suffer, let me do it now while I’m already suffering, not later after I’ve gotten over the bad times and am looking forward to enjoying prosperity. I can’t help but wonder if it wouldn’t make sense to just let interest rates float to their natural level right now and just give the economy time to work its way thorough the excess inventory of homes. Yes, this process will take longer than the lowering of interest rates approach, but at least we won’t have to deal with much more expensive homes in the future. Besides, I can’t help but feel that a lot of the economic issues we face now are the result of our band-aiding things so we don’t have to “face the music”. Maybe it’s finally time to live within our means, buy as much home as we can afford (which may be much less than what we may want), and build a strong financial and economic foundation for our children. Of course, that won’t get me votes with the public if I were running for any kind of office…

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