June 10, 2007

If interest rates hit 8%, will home prices go back to 2000 levels (or worse)?



The big problem with this stupidity of buying an asset based solely on the debt service cost (i.e. monthly payment) versus the asset's earning potential (i.e. rent) and potential net cash flow (rent income minus carrying costs) is that people assumed interest rates would stay abnormally and historically low, and that rental income on housing was irrelevant.

Well, I think we see now the folly of the current housing market. It'll always be the P/E stupid. And now that rates are rising, the proposition gets even worse.

It was a fluke that rates dropped so low these past few years. Thank you to the Japanese real estate crash, which forced the BOJ to take their rates down to 0%, which forced us (thank you 9/11 and Greenspan stupidity) to take our rates down to an insane 1%.

And thank you China for buying up our bonds to keep our interest rates abnormally low, and to manipulate your own currency so you could flood our market with cheap imports and crush our manufacturing sector.

Well, the days of stupid low interest rates are now over.

And now, the fools (as in the vast majority of people) who bought based on monthy payment and hope and promise of future price appreciation are about to find out what happens to payments (thank you ARMs) when rates go back up to normal levels, and appreciation turns into depreciation.

Hint - it ain't pretty.

41 comments:

Anonymous said...

This was the first good post to this blog in a while.

Anonymous said...

I think the article's author shares the same delusion as Roach at Morgan Stanley - while global rebalancing or the end of the carry trade might be in everyone's long-term interest, its in nobody's short-term interest. Just as China has no short-term interest in allowing it's currency to appreciate, Japan has no short-term interest in ending its ZIRP. The Japanese government's debt is 160% of GDP. It would make no sense to pay higher interest on that pile, which is nigh on overwhelming. Raising interest rates would also make the yen stronger, which would push down exports - something they are desperate to avoid, especially now that Korea has rising to nearly the same level on the food chain and China is coming on strong.

Anyway, the push that sends America over the edge will come from the inside or the Middle East, not East Asia.

acidrock said...

Wage inflation is heating up after several years of 5%-10% price inflation. People at all levels are expecting higher pay, and that's going to bump employment costs sharply higher when overhead and benefits are tacked on. Fear of higher payroll costs was a big reason businesses backed the Senate immigration amnesty bill. Does it end there? No, these higher costs lead to more price inflation. Add to that a declining U.S. dollar and you've set the stage for the next bubble - an inflationary blowout and issuance of a new currency.

Interest rates at 8% are absurd if price inflation is 10%. Expect rates to go much higher. People who locked in 6%, fixed rate mortgages and have secure jobs will be sitting pretty as they watch inflation trivialize their monthly payments. Retirees on fixed incomes and renters will be eating Alpo (when they can afford it) as inflation destroys their standard of living.

All you "cash" sitters will be screwed as well because one of the first thing the Feds will do is set up controls to keep you from moving that money. They might even "borrow" it for a while and give you an IOU (like they did in Argentina) so you can do your part as a good citizen and help out those "less fortunate".

TJH said...

I've seen a couple of videos discussing how the Federal Reserve should be abolished. I'm curious what lending would be like if there were no Fed to regulate the economy. At first, I think if there is not Fed, there is an effective interest rate of zero. Obviously, that will not happen because we tend to seek out relationships that are mutually beneficial, i.e. supply/demand (market) determines the interest rate.

Would lending rates be anchored to what the local market bears, instead of the 10 Year treasury note?

Anonymous said...

If? You mean when

crime of the century said...

"In the end, there is nothing but sorrow for what they have done."..

Supertramp
Brother Where You Bound

Anonymous said...

Jesus christ you're taking advice from a Turkish paper?

Mort said...

tjh works for the fed. lmao. Yeah, having the fed around makes everything fair, they print the money and give it to their friends and then the rest of us get to lick the boot. What a great system!

bagboy said...

Too late Bubba, the Fed is like that creature in Alien and it's financial tentacles are completely interwoven in the banking system. Removing it would kill the host.

Using a grocery analogy, the Fed is like Wal-Mart. It provides tremendous economies of scale and efficiencies in delivery and inventory. Banking without the Fed is certainly possible, just as we'd still have grocery stores without W-M. But it would limit us to local produce, we'd have fewer choices for other goods, and they'd sell at much higher prices.

Mark in San Diego said...

High interest rates sow the seeds for the next recession - when Volker raised rates (early 80's), he put the economy into the worst recession since the great depression - 10% unemployment! Hence, as the 10 year treasury continues to sell off and rates go up, it will kill the debt-fueled US economy - even 7% will do it, and increase unemployment. . .the good news (as it was in the 1980's) is that consumption decreases, prices of some items drop. . .even oil would drop as world demand decreases. . .not the hat trick is to have a "garden style" recession, now a full blowout.

Anonymous said...

If t's not about monthly payment then why does everyone here say I pay 1/2 in rent compared to what it cost to buy? Hmmm sounds like monthly payment is important.

Can't have it both ways. Either it is about the monthly payment or it isn't.

Guy Noir said...

Acidrock,

You're kidding, right?

If not, you apparently haven't yet been dissuaded from the deluded belief in the "priced out forever" fallacy.

Rising wages and higher interest rates would cause the price/rent ratio to fall back to historical affordability. At 8% rates, Joe and Jane Howmuchamonth would be able to afford a lot less house, especially since the exotic loan well is nearly dry.

Guy

Anonymous said...

Interest rates will continue to go up, as the fed will do anything to prop up the dollar, and those institutions that are allowed to borrow yen at .5% and take that cheep money and buy US treauries at increasingly larger yields of 5.5% + are greedy and they will always want more and more free money from their virtual money tree. It would be nice to talk to someone that knows what it takes to get on that yen carrytrade tit. ANYONE? Keith...

ttt said...

The only wage inflation occurring is in the developing countries and at the executive levels in the West. The coming recession will only make things worse

Anonymous said...

Slow train wreck. home values will sink over ten years. People will work 2 jobs, get rid of cars, divorce, send kids to JC college before giving up their house. People have already given away future retirement by the negative savings rate so to have the house and cars. Most of this negative savings will not show up until these people are in there 50-60 and want to retire and figure out they spent all the money on taxes and i/o and high payments. Everyone think the people around are doing great because the wife is at home and they have nice cars big house, gardner, granite,60 inch t.v. and all the bullshit for the kids. Nobody asks did you save any money this year for retirement. It's tough not being like "the jones".

DM123 said...

It's important to understand that interest rates don't control what the RE market does. In the 90's rate went down and down as the market slowed and it didn't change a thing. The RE market sucked.

What interest rates do control is the speed. In the case of the 90's it slowed the correction down. After 2000 when the market shifted into it's latest boom, the low intrest rates accelerated things. Now that the market has peaked and shifted to a bust market the rising rates will accelerate things.

What this means is that even if you dumped rates to the floor it won't do anything to save the RE market.

I'm just starting to see the blood in the streets in my area. Soon there will be a nation wide river of blood....

Anonymous said...

got gold

Anonymous said...

>> I've seen a couple of videos discussing how the Federal Reserve should be abolished. I'm curious what lending would be like if there were no Fed to regulate the economy.

Gee, let's start with actual competition between banks. Every time I see that Lending Tree commercial that says "When banks compete, you win.." (or something like that), I have to laugh. The Fed completely controls how every bank loans money, what the interest rates are, etc. The Fed doesn't want any competition - or if you believe the conspiracy folks, it's the Fed's private owners who don't want the competition.

Ever notice when either the US nation-builds, or some shit-hole country self-creates/gets-created, the first thing "they" do is setup a central banking system to financially enslave the population?

acidrock said...

Rising wages and higher interest rates would cause the price/rent ratio to fall back to historical affordability.

Rents increase with inflation because real investors don't like negative cash flow on their rental properties. The notion that rents are going down, as some regularly opine here, is just ignorant. Sure, everybody has heard a story about renting a $1 million house for $2500 a month - like that happens every five minutes.

At 10%, inflation should double wages and prices in about seven years. Prices on many common necessities have doubled since 2001, but wages are lagging. I think wages are about to catch up with a vengence.

There is a time-honored solution to the mess the Fed has created, and it's called inflation. When everybody, except renting HPers sitting on a mattress stuffed with cash, needs inflation to solve their problems, who do you suppose might be on the right side of that argument?

Anonymous said...

I tend to agree with the blue trend line that is pictured. Maybe it could be a little higher, but no higher than the 150% mark. Should be interesting to watch prices return to that level over the next 18 months!

Shaster said...

What if they fly past 11%? Happened before.

burn baby burn said...

Screw gold buy lead!

Acidrockgetofftheacid said...

Acidrock,

You forget how connected the system is. If price inflation were to get even a few points above the annointed 3% you would see a sharp rise in interest and mortgage rates.

Combine that with the fact that this bubble formed based on the assumption that long term rates were not only permanently low, but would go even lower and those who bought their house in the last couple of years could see their house at the same price 10 years from now....possibly longer.

I on the other hand, have 100% of my money in stocks. When inflation causes a loaf of bread to increase by 10%, that just increases corporate sales and profit by 10%. High inflation noticably increases the value stocks over time, if not in real terms, certainly in nominal.

Plus I'm diversified 50% plus overseas where growth will way outpace the US's anemic growth. You , on the other hand, have all your eggs in one basket.

So who's really holding all the risk?

Anonymous said...

acidrockgetofftheacid is 100% correct. If high inflation is coming, owning debt and stocks is the way to go.

As for inflation itself, where is this 10% inflation out there? Oh milk went up $1 a gallon. Gee wiz I buy 2 gallons of milk a month and I have to spend $2 more. Milk as a of my income is less than 1/100 of 1%. What matters to me is that my mortgage payment which is 25% of my income has NOT increased at all since last year and won't increase for the next 26 years (can you say that about your rent btw?). I pad $199 for a new cell phone last year, that same phone can be had for $19.99 on Verizon's web site today. My car insuarnce went up a whopping $15 from $781 to $796 for 12 months. Ouch a whole 1.92%.

Get some perspective people.

Roccman said...

"I on the other hand, have 100% of my money in stocks"

Hmmmmmmmmmmmmmmmmmmmmmmmmmm...

Every publically traded company tacitly assumes cheap oil will continue to be available to fuel widget making factories.

Peak oil occurred in 2005.

Cheap oil is a thing of the past.

Because oil is a fungible commodity demand destruction will not lower prices...rather bidding wars will price the poor out.

Therefore oil will continue to be more expensive and all publically traded stocks are currently very much over valued.

Expect a "correction" or whatever word you want to use that makes you sleep better at night.

Got gold?

Got Bunker?

Cheers

acidrock said...

"You forget how connected the system is. If price inflation were to get even a few points above the annointed 3% you would see a sharp rise in interest and mortgage rates."

Inflation is easily 5%-10% for food, energy, medical care, tuition, etc., and we all know what it's running in housing. The official government inflation index is a snow job.

Interest rates are low because China and Japan keep buying our Treasury paper. That keeps American consumers in a position to buy their exports. Happy-happy.

"I on the other hand, have 100% of my money in stocks. When inflation causes a loaf of bread to increase by 10%, that just increases corporate sales and profit by 10%."

You do realize that a 50% decline in share prices wipes out a 100% gain?

RJ said...

acidrock said:
Wage inflation is heating up after several years of 5%-10% price inflation.

According to the Bureau of Labor Statistics, wage and salary costs have gone up a paltry .9% year over year versus, as you correctly pointed out, 10% + real inflation. What numbers are you looking at to lead you to the conclusion that real wages are heating up?

Given real inflation, real GDP is in contraction (see www.shadowstats.com). We are already experiencing the beginning of an inflationary recession. This means depressed employment and wages while prices increase, especially if you factor in rising energy costs. My conclusions have not changed. The coming economic environment will be good for those who bought a house at a good fixed rate and plan to live there for a looong time and can maintain employment. The market will also be good for those who have a large down thanks to wise investments and can buy as the RE market bottoms out. Rents should go up with everything else unless things get so bad that people in large numbers are living on the streets.
Not gloom and doom. Just looking at the numbers. The housing industry supported the U.S. economy to a large degree. That support is eroding quickly.

Roccman said...

"We are already experiencing the beginning of an inflationary recession. This means depressed employment and wages while prices increase, especially if you factor in rising energy costs. "

Translation:

70's style stagflation with a twist.

The twist - no more cheap oil available to pull us out of this housing triggered Depression.

Full on bone crushing thud dead ahead.

Got gold?

Anonymous said...

Rates go up, fewer people can qualify/afford a mortgage, demand drops, prices drop due to excess supply chasing too few eligible buyers. Basic economics.

Anonymous said...

interest rates will never hit 8%. The printing press call the fed reserve will never let that happen.

offshoring said...

Any wage inflation will only end up sending more jobs to Chindia. Most of the new at&t call centers are being set up in India now. They even train the peons there to speak with a Southern accent and choose English names. I wonder who will but their products when most Americans will end up out of work? Maybe they can sell their products to the peons in Africa and Asia who make $3/day.

Anonymous said...

"As for inflation itself, where is this 10% inflation out there? Oh milk went up $1 a gallon. Gee wiz I buy 2 gallons of milk a month and I have to spend $2 more. Milk as a of my income is less than 1/100 of 1%. What matters to me is that my mortgage payment which is 25% of my income has NOT increased at all since last year and won't increase for the next 26 years (can you say that about your rent btw?). I pad $199 for a new cell phone last year, that same phone can be had for $19.99 on Verizon's web site today. My car insuarnce went up a whopping $15 from $781 to $796 for 12 months. Ouch a whole 1.92%."

This has nothing to do with the over inflated values of homes in many areas, you stupid moron!

Anonymous said...

iN MAUI YOU CAN RENT A MILLION $ HOME ALL DAY FOR 2,500 TO 3000. NO LIE. THE CHEAPEST HOUSES SELL FOR 600,000 WHICH CAN BE RENTED FOR 1700 TO 2000. JUST A BUNCH OF SHIT WORK JOBS. BUT YOUR IN MAUI.

Anonymous said...

"interest rates will never hit 8%. The printing press call the fed reserve will never let that happen. "

Rate have been way above 8% in the past and there is no reason they cannot surpass that again. The Fed is not going to keep rates down just to please homebuyers who bit off more than they could chew. And besides, the fed has little control over long term rates, something most people do not even realize.

Anonymous said...

back to 1995 prices!!!!

Anonymous said...

Anonymous said...
"As for inflation itself, where is this 10% inflation out there? Oh milk went up $1 a gallon. Gee wiz I buy 2 gallons of milk a month and I have to spend $2 more. Milk as a of my income is less than 1/100 of 1%. What matters to me is that my mortgage payment which is 25% of my income has NOT increased at all since last year and won't increase for the next 26 years (can you say that about your rent btw?). I pad $199 for a new cell phone last year, that same phone can be had for $19.99 on Verizon's web site today. My car insuarnce went up a whopping $15 from $781 to $796 for 12 months. Ouch a whole 1.92%."

This has nothing to do with the over inflated values of homes in many areas, you stupid moron!

June 11, 2007 1:15 AM

---------------------------------

You must have scored really low on your SATs. And hence why you rent. And hence why you care that milk is up $1. That post was not about housing you dumb fuck it was about general inflation.

acidrock said...

"According to the Bureau of Labor Statistics, wage and salary costs "

Too funny! The same goons who fudge their computer models to tell us we have a 1% "core" CPI tell us we have nothing to worry about for wage inflation - and you believe them!

Where I live unemployment is about 3%, and that 3% consists mainly of lock-ups, the chronic lazy, or disabled. There is no unemployment among the regular population and "now hiring" signs and job fair announcements are everywhere. Under those conditions it is impossible for wages not to rise. Figure it out smart guy.

eddy said...

Anonymous wants to know "where is this 10% inflation out there?"

If you weren't living in your Mom's basement playing Xbox games all day, you might have noticed the prices for cars, tools, groceries, gasoline, and just about everything else have gone up dramatically over the past four years.

Anonymous said...

This reversion to the mean is going to be very ugly. I'd hate to see the downside of this latest peak, but of course we all will ove the next 5 years.

Anonymous said...

"According to the Bureau of Labor Statistics, wage and salary costs "

Too funny! The same goons who fudge their computer models to tell us we have a 1% "core" CPI tell us we have nothing to worry about for wage inflation - and you believe them!

Where I live unemployment is about 3%, and that 3% consists mainly of lock-ups, the chronic lazy, or disabled. There is no unemployment among the regular population and "now hiring" signs and job fair announcements are everywhere. Under those conditions it is impossible for wages not to rise. Figure it out smart guy.

June 11, 2007 12:58 PM



You are assuming that employers will grant the wish of their employees with a "living wage". This is not the case. As cheap imports flood our market, and our addiction to buying these items it becomes a viscious cycle down. If inflation becomes a problem it means that fewer companies can survive as people will bunker down and not spend like drunken sailors. Even IF they give you a raise, inflation will always have a tendency to outpace any wage increase.

ghost of the holistic hebrew said...

Housing will never reach 2000 levels because the dollar will never again see it's 2000 buying power.