It remains immensely foolish to buy a house: Part 1
americancompass.org
In part one of our series on the lunacy of buying into real estate, we consider the interest rate argument. Home mortgage rates are not only at cyclical lows, but at all time lows. Some banks are offering 30 year fixed rates at 4.375% as of January 4, 2010. Now’s the best time ever to buy, right?
Banks, buttressed by the Federal Reserve and Obama administration, are using the well known bond price:yield formula to skewer the public. Too many Americans have faith in their government’s stability measures and little understanding of basic finance. This combination leads to a fatal misunderstanding of the real estate market.
Let’s walk through how ridiculous the “rates have never been lower” argument is. We’ll use the 30 year US treasury as an example since most home loans have about the same term. Here’s a chart of the yield on the 30 year treasury since 1977.
For 30 years, treasury yields have fallen as asset values have risen. Can yields drop any lower?
Treasury bond prices are very similar to home loans. When interest rates are high, as they were in 1980, the price of these bonds is quite low. No one wants to hold these bonds because they expect rates will go higher still. The bonds sell at a discount to their face value. The government hates issuing debt at rates this high because it must make interest payments at these extremely high yields. The opposite is true when rates are low. The government loves issuing more debt because the cost of servicing these debts is so low.
Consider now the consequence of progressively lower bond yields as shown in the figure above. As the 30 year treasury falls, the price of bonds rise. Similarly, when mortgage rates fall, the underlying asset (home prices) increases in value. Banks love it when mortgage rates are low because the principal is higher. Banks also like occasional foreclosures (as opposed to the mass foreclosures we see now) because after they seize the home, they can resell that home for the same or higher price. Banks always win with sporadic foreclosures; the population wins with mass foreclosures. Just imagine the effect on US bond prices if China dumped all their US denominated treasuries on the market.
For 30 years, Americans have witnessed a steady fall in interest rates with an initially slow (followed by a rapid) rise in home prices. But in 2008, something interesting happened: interest rates collapsed. The 30 year bond could conceivably fall to zero still, but it’s highly unlikely. How could anyone possibly bet on zero inflation over 30 years in the United States?
So, there are only 2 realistic possibilities with interest rates at this time. First, they could rise with an inflationary monetary policy, which would drive home prices down. Or they could remain low for years signaling Japanese style deflation, which would also drive home prices lower.
But too many Americans are simpletons in regard to interest rates. Let us spell it out more clearly: if interest rates rise, nominal home prices may remain steady or even increase; the real price will fall. If interest rates stay low, both nominal and real prices will fall. Yet another reason simple Americans should root for deflation. It’s just easier for all of us to understand.
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