Thu, 29 Nov 2012, 4:18am PST
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When reading the scales for housing prices, it's foolish to say that housing is going up by itself when the FED has its thumb placed squarely on the other end of the beam. It is not just important to know that housing prices are going up, but also to know WHY they are going up.
A fundamental nautical truism states that a rising tide lifts all boats. This is equally. albeit oppositely, true in matters of asset values purchased with borrowed money. I.e., a falling interest rate lifts all housing prices.
But high tide only lasts for so long, and when the tide goes out, it exposes all manner of derelicts that are hidden by the waters. As Warren Buffett said about the option market: "No one knows who is swimming naked until the tide goes out."
When rates rise, the housing market will lose its hidden stimulus. In fact, if the rates just stop falling there will be less yearly increase in purchasing power. In contrast to the economic bubble we experienced from the housing boom via heloc borrowing, we are now experiencing a housing boom as a result of falling interest rates stemming from an economic collapse! How ironic is that?
I believe we are at, or at least very close to, the bottom in the interest rate cycle. Absent the rebirth of NegAm Option ARMs, 3% is just about the floor for a 30yr FRM. If rates are at a nadir, then. for any given debt-to-income ratio and down payment percentage. housing prices are at their zenith. As rates rise, buyers will have to put more down and take on more monthly debt to afford the same priced house.
To offset the impact of rising mortgage rates, incomes must outpace inflation. It's hard to see how incomes will rise in an environment of rising taxes and falling salaries and benefits.
The Federal Reserve's plan is to drive down borrowing costs, allow severely underwater homeowners to either default or refinance through the GSEs, and thereby increase the discretionary income of the average household to jumpstart the economy.
Unfortunately, governmental stupidity is also at its zenith. Regulatory and tax uncertainty is causing economic malaise resulting in companies focusing on cutting costs to increase profits instead of expanding their revenues. Any increase in discretionary income created by the FED is more than taken away by increases in insurance premiums, reduction in hours and/or wages, increases in copays or deductibles, or increases in savings for retirement, college education, or emergency funds.