In the course of writing about real estate, I’ve become more versed in things like macro and microeconomics, monetary policy and the exploits of the boys and girls in DC than I ever intended. Why, because they all affect buying and owning real estate to one degree or another. So, I spend quite a bit of time researching these topics so that I can be more informative to my clients.
But lately, I’m troubled by the conclusions the data suggests. I say troubled because the so-called experts
keep talking about recoveries and rebounds while the actual data is quite different. These folks use computer models, fancy sounding theoretical terms and lots of letters behind their names to explain why apparently bad data is really good news.
So, while I’ll admit that I’m not the sharpest tool in the shed, I am in the shed. I know that 2+2=4 and 2-2=0. It doesn’t matter if a theoretical model says otherwise; a simple experiment with matchsticks will prove the fact. This is the source of my trouble.
I, like many Realtors, am regularly asked my opinion about the market and what the future holds. Mostly, I say that my crystal ball is in the shop and refer folks to the experts. But lately, I’m feeling guilty about this. Why? Because the experts make predictions, but their reasons for making those predictions don’t make good sense if you pull just one layer off of the onion.
Let me give an example. We keep hearing about housing turning the corner and stabilizing. When all the dialogue is boiled down, their reason is because it always has in the past. They point to this or that historic event and say that downturns are followed by upturns. OK, I get it, day follows night, but why is housing poised for a turnaround?
If you are a firm believer that good times are just around the corner and I have no business bringing the topic up, stop reading now. But if you’re wondering why recovery always seems to be in the next quarter, hang on for a scary couple of posts.
One of the arguments that housing will recover is the artificially low interest rates. These rates make homes more affordable so more people will buy. In theory, they are correct. If rates are low, mortgage payments are lower and property is more affordable. Simple. Right? But what happens if the rates are “artificially” low for an extended amount of time? In fact, why force already low rates lower?
First, let’s look at what interest on a loan really is. Money is a commodity. Interest is the price of money. The price of a commodity is dictated by supply and demand. If there is more supply relative to demand, the price—interest rate—goes down. Less supply and the price rises. So if there is less demand for loans, the price of the loans (interest rate) goes down. It works the same way for corn, oil and swizzle sticks. In housing, the demand for mortgage money is way down, so rates should be low anyway. Why would Washington want to push them lower?
Surprise! To support prices. Huh? How does that work? You see, most folks don’t shop for the house they need, they shop for the most house they can afford. For example, let’s say Lutherette can afford $500 a month for a home. At 4%, she can buy a $100,000 house. But if the interest rate is 6%, she can only buy an $80,000 home. If Lutherette represents the average buyer in that neighborhood, then manipulating the interest rate on the mortgage can increase our example property’s market value.
When low interest rates are the result of supply and demand market forces, more folks can afford more home and that’s good. But if interest rates are driven artificially low by outside—aka: governmental—manipulation, the effect is to hold housing prices above where supply and demand would dictate.
This is a new wrinkle in the market and sets the market up for another bubble. Why? Because of the other never before seen piece of governmental manipulation known as quantitative easing. What is that? Printing money. Lots of money. In the past three years the amount of dollars in existence as represented by the monetary base (MB) has tripled from about $800 billion to $2.6 trillion. Now to be fair, the monetary base has to grow over time as the economy creates more value. More people working and buying more stuff requires more cash. But, has the economy grown 200% since 2008?
While the government has printed extra cash to help the economy in the past, the scale of this recent manipulation dwarfs all previous printings combined. In other words, we are in uncharted waters. Remember, money is a commodity and like all commodities, it is subject to its value fluctuating with supply and demand. If you double the supply of say condos without an equivalent increase in demand, the value of condos goes down--a lot. Money works the same way, unless there is another force manipulating the system. That outside force is that much of this new money is “parked” in banks. Lack of demand is helping to keep it out of circulation. Why would these “money center” banks hold onto this money? Because the boys and girls in Washington are paying them to hold it.
What happens when the economy starts to pickup a little steam interest goes up so that the banks can make more by lending the money than what the government can afford to pay for parking fees and that money starts to enter the economy? History tells us that a money supply that grows faster than the economy causes inflation roughly proportional to the overage in money supply. Does that mean that we are looking at 200% inflation? I doubt it, but 15% per year would hurt, especially if it lasts for very long.
Some folks think that any price increase is inflation. This is not true. Price is a function of supply/demand economics while inflation is a monetary phenomenon. It is the change in the value of the money used to purchase the item. In inflation, goods cost more because the money used to purchase them is worth less so it takes more money to buy everything. This means that an item can get cheaper relative to other items while still requiring more dollars to purchase.
So, we have artificially low interest rates supporting housing prices and a greatly increased money supply. When this extra money starts entering the economy, what will happen to the price of funds? History tells us that inflation spurs interest rates to rise. This is because loans are repaid with ever cheapening dollars so lenders require borrowers to pay back more dollars to make up the difference.
If mortgage rates are used to support home prices, what happens when interest rates go up? What if they go up to 10%? Suddenly, Lutherette’s $500 mortgage payment that buys a $100,000 house today will only buy a $60,000 house. Her buying ability will be cut by 40% and to add insult to injury, her dollars will be worth less requiring her to spend more for everything else. This further limits her ability to buy a home.
Are you starting to understand my concern? More next time.