Easy money reflating house prices

June 30, 2009


My colleague Chris Swann says to beware of housing false dawns. I couldn’t agree more.  While the pace of decline in house prices moderated in April, one has to consider the stupendous monetary stimulus that helped drive that improvement.  With rates about as low as they can go, the only way to drive a sustainable increase in prices is to increase buyers’ income.  With the employment picture continuing to deteriorate, don’t look for rising incomes any time soon.

(Click chart to enlarge in new window)

The chart above plots the month-over-month change in the composite 20 index compared to average 30-year fixed-rate mortgages.

Bulls would point to an improvement in the so-called “second derivative,” a decline in the rate of decline.  From March to April prices dropped only 0.6%, far better than the 2%+ declines each of the prior six months.

Bears would argue that the data showed a similar increase a year ago, and then promptly turned back down.

But prices have fallen 18% since last year, bulls might say.  They can’t fall forever.

The trump card, however, falls to the Bears in my view:  Mortgage rates are 110 basis points lower today than they were just last fall.  That’s a lot of monetary stimulus.

When rates go down, prices go up (all else equal).  A quick present value calculation shows that a $3,000 monthly payment can pay off a $500,000 30-year mortgage priced at 6%.  Drop rates to 5% and that same monthly payment will support a $558,000 mortgage.

Admittedly, this is a simplistic way to look at house prices.  But it serves to show how incredibly sensitive they are to interest rates.

But low interest rates, along with lending structures that allow people to borrow more relative to their income, only offer a temporary sugar high for house prices.  There won’t be a sustainable increase in prices until there’s a sustainable increase in buyers’ income.  And that’s not happening any time soon, not with unemployment speeding towards double-digits.

For more charts analyzing today’s Case-Shiller data, see below.

slide13The first chart shows the decline in the 20-city index from peak to trough.

(Click chart to enlarge in new window)

Prices have now declined 33% from the peak, but remain 39% above 2000 levels, when the index was first calculated.


The table dissects the data by metro area.  In April, eight cities showed a month-over-month increase.  That compares to three in March.  The pertinent question: is the improvement merely a byproduct of easy money?


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I would like to know how the option arm resets starting in August of this year and continuing trhough 2011 could not have a significant impact on foreclosures and values going forward. Considering the numbers of 500 Billion and greater, how can any one consider that we are at the bottomn of the decline in values? Wishful thinking…………

Posted by Doug Kreuscher | Report as abusive

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Posted by Doug Kreuscher | Report as abusive

As I’m sure you know, the SP/Cash Shiller index reflects home price transactions over the 3 months ended in the month reported on. As such, the latest SPCS index, as anyone knows, does NOT reflect home prices in April relative to March. Rather, it reflects home prices in the 3-month period from February to Apri relative to the period from January to March. The report actually suggests that on average home price increased in April relative to March. You need to read the Lawler Economic & Housing Consulting daily report to figure out why, though it’s not hard to figure it out yourself.

Posted by Thomas Lawler | Report as abusive

The answer is without question! with realtytrac showing that banks inventory of foreclosed Properties that have not returned to the market is at 70% that means that the banks are and will continue to be the deflator of home prices.

Posted by bitran | Report as abusive

Congrats on the move to your new home!!

One important aspect of the housing affordability issue is the amount of the monthly payment rather than the interest rate. At the end of the day home buyers have to write a check which includes four components: interest, principal, property taxes, and homeowner’s insurance. A slight reduction in the amount of interest is nice, but the last two aren’t coming down anytime soon. Furthermore, a 30-year self-amortizing loan requires a principal payment which the various types of I/O, Option ARM, etc. loans did not require. So even with lower interest payments the monthly nut is not coming down much, if at all. And I believe that most Americans buy based on how much they think they can afford in a monthly payment. . .

Posted by But What do I Know? | Report as abusive

The observations in the article are sound if the market behaves in a rational manner to historically low interest rates. The idea that low rates should stabilize housing prices is short-sighted. It might improve liquidity if we consider the mathematical benefits only if lenders are actually willing to lend in a low-rate high-unemployment environment. The more likely scenario is higher asking prices and reduced access to capital. Rather than try to financially engineer a recovery in this sector, what we really need is more people with more buying power. We have implemented various nominal strategies to get consumers to spend. But governments cannot create wealth. If it were that simple, somebody would have discovered the trick by now.

Posted by Don | Report as abusive

[…] a very interesting article on Reuters about low mortgage rates helping the housing market located here.  It is an interested perspective in that the article explains that easy money is making home […]

Posted by Low Mortgage Rates Helping the Housing Market? – Economic Conversation | Report as abusive

Thanks for info about house prices.

Posted by house prices | Report as abusive