How Fed Policy Distorts Home Prices
I’ve about had it with how giddy a large portion of the U.S. population has become about rising home prices.
Don’t get me wrong, when first thinking about this, I was about as happy as anyone else to learn that property values are now rising sharply again since, after renting for six years, my wife and I finally bought a house about two years ago. So, we stand to benefit as much as anyone else.
But, when you look at what’s driving home prices higher and how unnatural and unsustainable those factors are, suddenly the headlines sound more ominous than optimistic.
The glee of Diane Sawyer and David Muir was nearly uncontrollable on ABC News last night as they detailed the latest findings from Corelogic showing that home prices rose by over 6 percent from a year ago.
This video is the closest that I could find at ABC News, but you get the idea.
This LA Times report detailed the findings of a UCLA Anderson Forecast study that indicated the “housing market is becoming the leading source of strength for the long-sluggish American economic recovery“.
On the surface, this sounds like a good thing, but not when you examine what’s driving home prices.
Yes, low inventory is a big factor behind the home price surge as the flood of foreclosures has slowed to a trickle while strong investor demand and growing confidence amongst American consumers have surely tipped the scales in favor of higher prices. But, it is today’s freakishly low interest rates - engineered by the Federal Reserve - that have clearly played the biggest role in pushing home prices higher, simply because most people buy a house based on the monthly mortgage payment, not the purchase price.
And when you see the impact record low rates have on purchase prices, you might be as concerned as I am.
I never thought I’d see the day when you could get a 30-year fixed rate loan at just 3.31 percent, but that was the case last week according to Freddie Mac’s weekly survey of mortgage lenders. While most people probably just shake their head at these astonishingly low numbers, it is homebuyers who are seeing the kind of impact they have on monthly mortgage payments and, as shown below, this effect is profound.
Based on a constant mortgage payment of $1,100 per month (what seemed to be a good national average based on this story and others like it), today’s 3.31 percent 30-year mortgage rate will finance a house at almost double the price that the 40-year average mortgage rate would!
While there are clearly other factors involved, it is the Federal Reserve’s asset purchase program that is largely responsible for these freakishly low rates (it is one of their stated policy objectives) and, while the central bank has promised to keep rates low for a long time and to continue buying mortgage-backed securities indefinitely, those actions are by no means guaranteed.
As shown above, even if mortgage rates moved back up to their 20-year average rate of 6.5 percent (what many thought were simply unbelievable rates when they first dropped that low last decade), that same $1,100 mortgage payment would finance a home purchase of just $193,000, not the current $279,000.
The difference between these two prices is nearly 50 percent!
Go ahead and plug these numbers into any mortgage calculator and you’ll be as stunned as I was.
As shown below, we’ve really entered uncharted territory this year. During and after World War II, 30-year mortgage rates dipped below five percent for about a decade, but it’s been over a year now since we’ve read headlines like Mortgage rates now below even lows of early 1950s. If you go back a little further to peruse charts like these, you’ll find that mortgage rates didn’t come anywhere close to today’s 3.31 percent.
This wouldn’t be nearly as bad if not for the fact that, the lower rates go, the more extreme the impact is on home purchase prices, something that you don’t really realize until you do these calculations. Should 30-year mortgage rates drop to 2.5 percent - something that, somehow, seems quite possible in the year ahead - that same $1,100 mortgage payment will finance a home purchase of about $310,000 and, at 1.5 percent, it works out to be over $350,000!
This is starting to sound a lot like those 2005-era stories of people with $50,000 incomes buying $500,000 houses. How you end up there is much different (liar loans and interest-only loans versus super-low mortgage rates), but the underlying instability that this sort of financing creates is not all that different.
40 Responses to How Fed Policy Distorts Home Prices
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December 5, 2012
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December 5, 2012
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December 5, 2012
[...] that higher home prices are a signal of the recovery. Trouble is, the recovery is not organic. Tim Oacono provides a nice graphical representation of how record low mortgage rates courtesy of the Federal [...]
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December 5, 2012
[...] Read How Fed Policy Distorts Home Prices here. [...]
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December 5, 2012
[...] chart is taken from a recent post by Tim Iacono, who elegantly demonstrates just how distorted this Fed-driven market has [...]
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December 7, 2012
[...] points out, lower home mortgage interest rates can mean dramatically higher home prices. Iacano notes that with today’s record-low rates of 3.3%, an $1,100 per month mortgage payment can finance [...]
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December 10, 2012
[...] much more house? According to Tim Iacono of Iacono Research, at 3.3%, an $1,100 per month mortgage payment can buy a $280,000 house. (Yes, that’s ballpark [...]
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That really is incredible. I had no idea the impact was so big.
The sad thing is that they’ve only gotten a five or ten percent move up in home prices when lower interest rates alone would account for a much bigger increase.
The question I turn over in my head is if this is a re-inflation bubble and when can the Fed just stop buying these mortgages - or even just slow down? What happens when rates go “all the way” back up to 5% and homeowners are again underwater?
Or is this already recognized and the traditional mortgage has become a government product now and forever?
For the traditional mortgages Tim is discussing here, there is no “rates going all the way back up”. If you buy a 30-year mortgage at 3.31%, your interest rate will be locked at 3.31% until 2042. It can go as high as 15% or as low as 1% and it won’t matter, your rate is locked.
Now if you’re mortgage is adjustable, then you will be screwed when rates rise. IMO, though, after 2008 only fools would buy an adjustable mortgage. Adjustable mortgages are only worth it if you can envision interest rates going down over the life of the mortgage, and interest rates largely have one direction left to go - up.
Right, though my thought was selling the home after 5 or even 10 years. Once rates start to move higher, your future sales price will be affected by less buying power.
I think the wise play here is to be sure and not buy more home than you need. Cheaper homes have less room to fall in value, and higher interest rates will push many out of more pricey homes as interest rates rise.
Spend any extra money on getting a good neighborhood (or better yet, privacy and land outside urban areas) rather than size and amenities.
Renting may not help as rents could just rise along with rates. If at all possible I’d find a place to live the next decade-plus in if possible as these are not likely to be repeated low rates.
Except if you buy a home at a good price with a 30 yr fixed and 6 years later you need to sell and interest rates go from 3.3% to 5.0%. If housing prices respond to interest rates like bond prices, sellers would have to take a hit. Unless your 30 yr has an assumable feature to it - then buyer would need a bit larger downpayment.
You are missing the point entirely
The big banks want the Bernanke Backstop, whether the GSE’s exist or not. They want a government guaranteed housing bubble.
“the underlying instability that this sort of financing creates is not all that different”
Not true.
The instability of liar loans with teaser rates is materially higher then documented income with fixed rates. The percentage of cash sales (rate insensitive) is also quite high.
Just sayin’.
Like your blog.
Makes me wonder on say Adjustable Rates that as those loans now at a low rate increase with increased interest how many are gonna be underwater as the ‘affordability’ of their residence becomes more and more a burden on the monthly and ever decreasing household budget. Just wondering.
Look up Mark Hanson Advisers for some truth telling regarding the underbelly of the housing market distortions going on in many markets nationwide.
Good article, Tim-I’d just like to make two points.
1) While principal and interest part of the mortgage payment has fallen, the property tax and insurance portion keep rising. In my case, the latter portion accounts for 35% of my monthly payment. Add in maintenance costs for a home and you will note that we are reaching a point of diminishing returns vis-a-vis lower interest rates. You could take the rates down to zero and I would still be making about 60-70% of the payment I am making today. Granted, a chunk of this is principal, but still, my monthly nut wouldn’t go down more than 20%, given my cost of utilities, etc.
2) The destructive effect on home prices of an interest rate increase is one of the big reasons why the Fed can never allow rates to return to their “normal” levels. There is no going back, no matter what Ben and the other Merry Banksters say. We are proceeding with our eyes wide open in the direction of Japan-and for exactly the same reasons. It’s kind of ironic that the economic wizards can decry the actions which the Japanese have taken while following meekly on the same path, taking the same policy actions for the same reasons the Japanese did earlier-because they seemed like the best option at the time, heedless of the conclusion.
Smooth is the way and easy the path which leadeth on to perdition.
BWDIK
You nailed it! Everyone should read your comment several times to get the full import, especially point #2. We are headed for 20+ years of ZIRP a la Japan. There’s no way out. The Feds and politicians can keep this going for a LONG time. Plan accordingly…
If memory serves, total QE by Japan only amounts to about $1 trillion (I’m pretty sure that’s the case after all the reports about adding $125 billion more in September).
In the U.S., we’re about to start doing $1 trillion a year - that may make our situation different than theirs.
QE 1 and 2 in the US were $2.35 trillion in a $15 trillion economy or about 16% of GDP.
QE in Japan totals about $1 trillion, as you say, in a $6 trillion economy or about 16% of GDP.
By this metric, we’re at the same point.
As far as I can tell, there is no end to QE in Japan and it may even accelerate. Similarly, there is no end to QE in the US. It may or may not hit $1 trillion next year.
As BWDIK correctly noted, the Fed CANNOT allow rates to rise for several reasons. So, they simply will not let that happen.
If US rates rise due to market forces beyond the control of the Fed, then we are in a melt down situation and the only insurance is guns, gold and silver.
Since I already have those commodities in my possession (along with the related survival crap), I’m looking at this as an investor. As an investor, I see no end to ZIRP. In other words, do not count on rates increasing.
I understand and agree, but my point was about the timing and people saying it’ll be like this in the U.S. for 20 years like it’s been in Japan.
Since we’ve done as much QE in a few years as they did in a much longer period of time, that suggests we may not suffer the same sort of lost decades after we embark on $1 trillion a year in QE next month.
Of course, that fate may be worse than Japan’s.
True.
What fate do you imagine will befall the US if $1 Trillion QE goes ahead and WHEN do you see it happening?
A currency crisis of some sort, perhaps in the next 2-3 years.
Can’t seem to reply to your latest about a currency crisis in 2-3 years so I’m replying here…
To me, a currency crisis is the same thing as the meltdown I mentioned. If you’re right, then the world’s reserve currency and the biggest economy in the world for nearly 100 years (USA) is in a crash and that tells me we’re in the ‘gold and guns’ scenario I mentioned. In that case, “investments” don’t mean anything and we’re just trying to survive on what we’ve stashed in our personal hidey holes.
If you’re wrong, and a true crisis never happens in my life time, then I’m waiting for the End Times and I’m not investing based on what I know the US is clearly going to TRY to do, which is keep rates low for a VERY long time a la Japan.
I may be missing something, but I just don’t see a middle ground where you can “invest” on the idea that a currency crisis is 2-3 years away. You can PREPARE for a meltdown, but that’s not the same as investing for the long haul.
I’ve been reading blogs for years that have been calling for an “imminent” crisis. After a few years, they begin to sound like Harold Camping who set 5-21-12 as the date for the end of the world and then looked like a moron as the world breezed past his deadline…
I don’t think this is true:
“If US rates rise due to market forces beyond the control of the Fed, then we are in a melt down situation and the only insurance is guns, gold and silver.”
It’s not a bad thing to have this kind of insurance, but there are probably all kinds of possibilities short of a lawless society that this suggests, though I don’t know exactly what those possibilities are.
Hi, again, Tim
You wrote: “… there are probably all kinds of possibilities short of a lawless society that this suggests, though I don’t know exactly what those possibilities are.”
I thought long and hard before I wrote about the meltdown and guns. Like you, I initially thought there must be “all kinds of possibilities” short of that scenario but, like you, I was unable to come up with even ONE that was realistic.
Doesn’t that tell you something? A “currency crisis” is not just a very bad day on Wall Street. A true currency crisis means a sudden and rapid fall in the value of the currency also called an “attack” on a country’s currency.
If the US dollar is in a currency crisis, where do you think the other currencies like the Euro will be? How does it get to the point that the US dollar is in free fall without other currencies having already collapsed? What kind of a world is that? Do you think TPTB can manage such a situation when they couldn’t prevent the crisis in the first place?
There’s a reason we couldn’t imagine a scenario where there is a US currency crisis without it devolving to utter chaos.
For fun, I’ve added 4 Friday entries to my Outlook calendar:
December 6, 2013: 1 yr ago, iaconoresearch.com predicted US currency crisis in 2-3 years w/o lawlessness. Are we close?
December 5, 2014: 2 yrs ago, iaconoresearch.com predicted US currency crisis in 2-3 years w/o lawlessness. Is it happening?
December 4, 2015: 3 yrs ago, iaconoresearch.com predicted US currency crisis in 2-3 years w/o lawlessness. Did it happen?
December 2, 2016: How was the US currency crisis? Can you still read this? Hello? Hello?? Anybody there???…
For the record, that wasn’t really a prediction, I was suggesting the possibility.
This discussion may boil down to semantics. When I say currency “crisis”, I’m not talking about a currency “collapse”, in which case having a gun or two at the ready might be a good thing.
The world survived the 2008 financial “crisis” without too many fatalities, so, I think it has a good chance of enduring a U.S. currency “crisis” without too much social unrest.
With all due respect… (I enjoy the blog, especially the news items. Thanks for saving me a lot of time each morning!)
Semantics? I’m not sure…
My point was that we can expect US ZIRP for 20 yrs unless TSHTF.
Your initial point was that the US won’t have 20+ years of ZIRP like Japan has had because of an unspecified but non-violent, US “currency crisis” that might happen in 2-3 years because we’re doing more QE than Japan.
In the same vein, I also said that if the US loses control of interest rates, we’re in a SHTF scenario. You said “I don’t think this is true” because you thought there was some crisis short of that but you couldn’t exactly say what it was.
In other words, I don’t see anything short of a full blown collapse that will cause the Fed to abandon ZIRP while you DO see something in 2-3 years but can’t say what it is.
So, it’s not about the definition of ‘currency crisis’ but about consequences, timing the duration of ZIRP. (Notice that Obama and TPTB are in for another 4 years, which is longer than 2-3 years. Ron Paul didn’t even get on the ballot.)
Since I don’t think the world is likely to end, I conclude ZIRP is here to stay and invest accordingly (but I’m prepared as best I can for chaotic lawlessness).
ZIRP and QE are like meth: once you start, you can’t stop without serious problems. That is the lesson of Japan. ZIRP isn’t truly “working” here (or in Japan) but the Fed won’t just stop ZIRP and reverse policy because they can’t withstand the suffering it would cause. Higher rates would likely mean the end of the Fed and whoever was in control of the country at that time.
IMHO, if you don’t see that, you’re missing the fundamental lesson of Japan.
Interesting. My PT and insurance have actually dropped since 2008.. You may want to look into an appeal on the taxes.
Not that it proves anything, but we applied for a refi this time last year and were shocked that our home’s value was $50,000 below what we paid, as we are in a more moderate market (atlanta). We were pleasantly surprised to find the appraisal come in $40,000 above last year’s (using the same company).
We’ll save $2800 a year on interest.
There is no way one can count on any price stability in this environment. Home prices may rise temporarily due to the lower rates, but they will most certainly fall later as those rates inevitably rise and affordabiliy falls.
Not that it matters in the big picture as we are looking at either hyperinflation or complete social chaos and breakdown in the all-too-near future.
Props to Tim Iacono for getting this published at Financialsense. They don’t put just any junk out there.
Rates and home prices don’t necessarily have an inverse relationship.
As the economy improves and home prices presumably climb higher, rates also rise because good economic news means more inflationary concerns, which leads to higher interest rates.
There’s also the fact that not everyone takes out a mortgage - plenty of home buyers pay with cash.
And as another commenter pointed out, the interest portion of the housing payment is just one piece of the pie.
Today’s 3.3% is getting close to 1/3 that of the 40 year average.
“This is starting to sound a lot like those 2005-era stories of people with $50,000 incomes buying $500,000 houses. How you end up there is much different (liar loans and interest-only loans versus super-low mortgage rates), but the underlying instability that this sort of financing creates is not all that different.”
I’m sorry, I do not understand how these are the same. It seems to me that someone with a liar or IO loan is eventually going to be unable to pay the mortgage, either because the IO loan terminates (requiring a balloon payment) or they have mislead about their income.
In the case of low interest rates, though, if I can afford a $500,000 on my income because rates are low today, if I buy a $500,000 house with a fixed rate loan, why would I be as likely to default as someone in the above scenaria you describe? As long as the bank is doing due diligence to determine that I can indeed afford the monthly payment, then as long as I’m not on an ARM or balloon mortgage, I can pay.
In 2005, housing prices inflated because people were convinced to buy more home than they could afford. Today, people are able to buy more home than they used to be, but they can afford more home too.
“starting to sound a lot like” does not equal “these are the same”
The comment was directed at the effect this lending has on the underlying stability of the financial system (i.e., what happens to home prices when interest rates normalize) not whether the person can really afford the house.
In simple terms, just think of a see saw. On one side we have rates and on the other we have value. When rates drop than home values rise. When rates increase than home values decrease. It’s pretty straight forward and undeniably a fact
Zero down Mortgages and 3% Mortgages are back. For example, take a look at the numerous low money down Mortgages over through Massachusetts Housing Authority - these offering are oftne resold through participating Lenders (the idea that loans are hard to get is bogus).
Here is one zero down 30 year Mortgage product that targets low tier cities in Massachusetts - the down payment required is ZERO.
https://www.masshousing.com/portal/server.pt?open=514&objID=11583&parentname=CommunityPage&parentid=12&mode=2&in_hi_userid=2&cached=true
Then you have the ZERO down Mortgage just for Veterans, because Veterans would never lose a house through foreclosure….
https://www.masshousing.com/portal/server.pt?open=514&objID=3614&parentname=CommunityPage&parentid=14&mode=2&in_hi_userid=2&cached=true
These Housing Authorites, are non-profit financing companies, that are operating in many of the States where there has been a big bounce back in housing prices. I believe these Authorites are suppose to be making Housing affordable - but, end up flooding certain housing markets with liquidity and we all know what that does……….raises prices!
Here is the Mass Housing financing product for multi-family purchases where they provide 95% financing……https://www.masshousing.com/portal/server.pt?open=514&objID=18704&parentname=CommunityPage&parentid=16&mode=2&in_hi_userid=2&cached=true
Again, every time I hear housing numbers reported they always mention that the bounce back is happening when financing/mortgage is difficult to get………….not true!
Interest rates can be persistently low for decades with high debt to GDP ratios, low or zero inflation, and a high foreign exchange value. I’ve just described Japan. There’s nothing the central bank can do conventionally at the zero rate bound. Fiscal policy is needed — and not in the form of a world war.
Japan has actually done better than the U.S. in keeping people employed and in protecting a strong social safety net. But the U.S. isn’t a parliamentary system, and the House GOP is nuts.