I noticed something interesting in the news today. I was reading an article about the housing market, detailing that housing prices nationwide have dropped about 18% in the last year. The news article went on to state that more bad news was expected, as housing prices were expected to drop an additional 15-20% before leveling off at the end of 2009.
Why is it bad news when housing prices drop? Shelter is a basic human need. Housing is a product that we all use, and many of us would like more of. If housing prices fall, than buyers who were priced out of the market can now buy. Other buyers can now afford more house. From this perspective a drop in housing prices is good news.
“Oh, but what about the poor house sellers,” you may say. “Now they aren’t making any money when they sell their property.” Well, when big screen TV’s drop in price by 50% in a year, I don’t hear any boohooing over the fate of the poor TV manufacturers. What I hear is “Now I’m gonna get me a 54” wide screen. In HD. When those linemen hit that quarterback, I’m gonna see his ribs crack! A bigger TV is my right as an American. I heard it says so in the Constitution.”
Anyone who has lived in their house for five years or more isn’t going to be hurt by the drop in housing prices. Anyone looking to buy their first house is going to be helped by the drop in housing prices.
But what about the people losing their houses due to foreclosure? Well, they aren’t losing their houses because prices are dropping. They are losing their houses because they are not paying the mortgage. In many cases, they can’t afford the mortgage because the house was too expensive for their income.
The history of the housing boom over the last six years was people taking on more and more debt to buy ever more expensive houses. They were able to take on this debt because of mortgage products such as “liar’s loans” and negative amortization loans. The current process of price correction is mostly painful to the lenders, who are suffering the losses from loaning more money than people can afford to pay.
Housing prices are going to continue to slide until someone with the median household income can afford the mortgage payments on the median priced house. The faster that happens, the faster the housing sector, and the economy as a whole, will recover.
And that will be good news for everyone.
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2 comments:
Well the problem is that markets overshoot (I say this despite my Chicago School bias.). The housing price collapse has ruined the whole mortgage finance structure, not just the liars loan sector. Originations of mortgage-backed securities are down 87% in the first six months of 2008. The baby has been thrown out with the bathwater; mortgage interest rates relative to other rates are now much higher. This suppresses availability of housing as fewer people qualify for conventional loans, and it acts as a tax on new homebuyers. So it's not all roses even if you weren't long in the recent bubble.
The problems with the mortgage finance structure have more causes than the drop in housing prices. I would argue that the drop in orginations of MBS is due to the ratings. So many AAA rated tranches are belly up that the market has collapsed. This is primarily a credibility problem created by the ratings agencies.
I would further argue that the rise in mortgage interest rates is a rational response to the high rate of delinquencies and foreclosures in a soft economy. What interests me is the spread between the Fed funds rate and the mortgage rates. If the Fed drops the cost of money to the banks, but the banks keep rates high for borrowers, that increases the banks' margins. The banks now have increased profitability to offset their writeoffs of older bad loans.
This is what I call the Fed's "Russian strategy," trading distance for time. Keep interest rates to banks lower than would be expected in an inflationary environment, in order to allow the banks to earn enough money to continue writing off the bad debt. At the same time, allow the banks to avoid writedowns of such size as to make them insolvent.
My bottom line contention on housing, however, is that people are not going to spend more than X% of their total income on housing, where the golden percentage X is between 25% to 40%. When the mortgage payment (including taxes and insurance) begins to exceed that golden percentage, we begin to enter bubble territory, and a correction becomes inevitable.
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