February 9, 2006

Low Rates Enabled Speculative Excess, Not Higher ‘Values’

Rich Toscano writes at the Voice of San Diego “It is a fairly common tactic among housing-industry cheerleaders to cite low interest rates as an ‘economic fundamental’ underpinning current housing valuations. Lower interest rates mean lower monthly payments, and lower monthly payments justify higher home prices. Therefore, low interest rates make homes more valuable.”

“That this point of view is widely accepted is unsurprising. It is seductively simple to think that sale prices are irrelevant as long as monthly payments remain reasonable. But there are some problems with the argument that low interest rates should result in higher home prices.”

“If one treats a home as an investment, and it seems very clear that most San Diegans do view their homes as investments, then the cost of financing that investment is irrelevant.”

“After all, if I lend you money one day to buy a stock, and then the next day I lower the rate I am charging you for the loan; did the stock suddenly become more valuable on that second day? It sure didn’t. So why should a house be considered more valuable based on the rate at which one can borrow money to purchase it?”

“As a matter of fact, this same reasoning applies whether you consider the home an investment or not. If the checker at your local Vons charged you extra for that box of Cap’n Crunch because he found out that the bank had lowered your credit-card rate, would that go over well with you? Apparently the housing permabulls wouldn’t mind, because the monthly payments on the Cap’n Crunch stayed the same.”

“Now that rates have risen somewhat, and monthly payments with them, does this imply that home prices should have declined? If and when rates rise further, will homes become even less valuable?”

“To be clear, interest rates are important. Unusually low rates have allowed San Diego homebuyers to bid home prices up to previously unimaginable levels. But the speculative excess enabled by low rates will prove neither healthy nor long-lasting.”

“The idea that low interest rates make homes more fundamentally valuable is neither logically sound nor supported by the historical data. There are many fundamental factors that legitimately and sustainably influence home prices, but the level of interest rates is not one of them.”

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Comment by Ben Jones
2006-02-09 15:11:09

My thanks to Rich for sending this in.

Comment by mad_tiger
2006-02-09 15:18:16

“After all, if I lend you money one day to buy a stock, and then the next day I lower the rate I am charging you for the loan; did the stock suddenly become more valuable on that second day? It sure didn’t. So why should a house be considered more valuable based on the rate at which one can borrow money to purchase it?”


The value of any investment is the discounted stream of future cash flows, whether it’s interest, dividends, rent, or capital gains. The discount rate is directly tied to the interest rate. The lower the discount rate (divisor) the higher the present value of that future stream. If interest rates go down, then the discount rate goes down, and the present value of the investment goes up.

Comment by John in VA
2006-02-09 15:49:07

You’re making an error in applying discounted cash flow analysis to home purchasing decisions. This holds true for an investment in, say, a new factory or even an apartment building, but it is not an appropriate model to apply in the purchase of a home — particularly if the buyer may need to resell that home in 5-10 years. In that case, the buyer should be concerned with the DCF picture for the future purchaser. If I’m buying a house when rates are 4% but I expect them to rise to 8% in the timeframe that I need to sell, then I should anticipate what the discounted cash flow picture (and hence, the value) of the asset will be at that time. If I calculate that the DCF analysis will yield a value of $400K in 2009 and my purchase price in 2006 is $550K, then it is a mistake to purchase, regardless of my current hurdle rate and NPV.

Comment by JWM in SD
2006-02-09 16:12:32


You beat me to it. I used to work in the automotive component manufacture industry in the midwest (Chicago) and did a great deal of NPV analysis for decisions about plant equipment investments when completing RFQ;s from GM and Ford. Although, Mad_Tiger has the mechanics correct, the context is wrong.

Comment by GetStucco
2006-02-10 05:06:13

How does a buyer know when he will need to sell? Especially if he is a real estate industry worker who thinks home prices will always go up?

This is where irrational exuberance will really hurt — all the RE pros who moonlight as investors.

Comment by sven
2006-02-09 16:06:33

Not to mention you now have more incentive to buy another stock since you have more money in hand due to the lower interest rate.

Which affects demand.

But who cars, houses aren’t stocks.

Comment by Chris S
2006-02-09 16:35:36

Right - And when interest rates rise (like they are now…) …?

PV of imputed home income stream falls.

So where you believe interest rates are going has *a lot* to do with where you think CA housing prices are going.

Look at the article’s chart of historic 30 yr mortgage rates. Essentially every data point is much higher than what we have seen the last three years.

(Which interest rates, btw, have been Fed engineered to desperately try to restart the national labor market - a failed attempt if you consider the fact that http://www.bls.gov shows that the employment-to-population ratio is still at levels last seen over a decade ago…don’t trust the piece-of-shit unemployment rate as a metric - it defines the problem out of existence due to its lame ass definition of “labor force”…)

And, speaking of basic finance and economics, doesn’t the principle of supply and demand suggest that a nation which owes about $8 trillion in explicit debt and over $20 trillion in unfunded liabilities (Social Sec and Medicare, etc. - and which has recently had the lowest personal savings rate since the Great Depression) is at some point going to be looking down the ass end of some astronomically high interest rates?

To wit, if there is high demand for savings in order to pay off or roll over astronomical federal debts *and* there is a low supply of lendable savings - result: much higher interest rates necessary to attract funds.

Further result: Collapse in CA housing price bubble due to soaring interest rates

(Unless illegals start to decide to live 32 (vs. 16) to a house in SD and the ComChi pull another Tiananmen and an ass-load of Chinese factory manager flight capital flows into CA…)

Comment by Gasman
2006-02-09 17:06:25

You are right, but wrong as well. Houses are shelter. Shelter is priced in $$/unit time (rent if you like). So the current value of the house that you buy is the discounted value of the future shelter services you are purchasing. Of course the capital value goes up as the discount rate declines, but this is not an “investment”. It is prepaying for shelter. Of course if the house is purchased for you to rent out to someone else then it is an investment.

Comment by GetStucco
2006-02-10 05:02:51

Only partially wrong. The future discount rate is stochastic and hence, unknown. Asset values (like stocks, bonds, and houses) all tend to overshoot in part because most Wall Street types ended their educations before learning about stochastic discount rates. (The other reason is that it is easy to fleece sheep when asset prices go way above fundamental values and then again when they drop way below.)

Comment by Jim A.
2006-02-09 15:28:04

I have to agree with mad-tiger on this one. This article is curiously misguided.

Comment by AZgolfer
2006-02-09 15:29:17

Hi from Phoenix

I bought my house in 1993. Since that time I have had hundreds (maybe even thousands) of offers to refinance and lower my intrest rate. I did refinance (7 1/2 percent to 5 1/2 percent) with a 15 year mortgage about 4 years ago. Not once in the 13 years I have owned my house has the bank offered to reduce my principle. NOT EVEN ONCE. I would much rather have a lower principle than a lower rate any day. How many times in a 30 year loan do you suppose you will have the opportunity to lower the rate? Isn’t this “only focus on the monthly payment” a used car pitch?

Comment by Ben Jones
2006-02-09 15:34:10

But the cash flow on San Diego houses bought today would be negative. There is no stream. Low interest rates don’t make me want to buy an overpriced asset.

Comment by mrincomestram
2006-02-09 15:49:27

Bought today yesterday and for at least a year or two before then.

Comment by Mo Money
2006-02-09 16:03:28

well that was totally incoherent…..

Comment by mrincomestream
2006-02-09 16:24:06

Comment by Ben Jones:
But the cash flow on San Diego houses bought today would be negative.

Comment by mrincomestram:
Bought today yesterday and for at least a year or two before then.

Is that a little clearer now. My point being I haven’t seen a house with a true positive cash flow for a couple of years. Especially in my area. And if one is truly truthful about the expenses. It’s amaing too me how many fly by night speculators forget to add things like property taxes in their analysis. It seems the only thing that matters is that the payment is 100 and the rent is 125

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Comment by mrincomestream
2006-02-09 16:27:26

Comment by Ben Jones:
But the cash flow on San Diego houses bought today would be negative.

Comment by mrincomestram:
Bought today yesterday and for at least a year or two before then.

Is that a little clearer now. My point being I haven’t seen a house with a true positive cash flow for a couple of years. Especially in my area and if one is truly truthful about the expenses. It’s amazing too me how many fly by night speculators forget to add things like property taxes in their analysis. It seems the only thing that matters is that the payment is 100 and the rent is 125

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Comment by goleta
2006-02-09 16:10:04

During the early 90’s bust, the prices kept falling even when you could get positive cash flow with most homes in NY and LA. The interest rates were also falling if I remember it correctly. Ever lowering rates didn’t stop Japan’s RE market collapse either.

The same thing happens in the stock market too. You can find stocks that pay 10% or more dividends yet no one is buying when people expect the stock prices to fall.

Comment by GetStucco
2006-02-10 05:15:25


Exactly! This is why the investment value of SD homes under current market conditions is negative. I guess that explains why there are more than five times as many homes on the market right now than in Spring 2004.

Comment by Uncle_Git
2006-02-09 15:40:08

The current trend is focus on the teaser monthly payment (your I/O ARM), ignore the long term payments - you know the principle and adjusting rates…

Hey RE always goes up - you can sell in 3 years anyway to the next guy.

Except then the rates will be higher, minimal wage inflation will leave them being able to pay a very much lower price for your house to have the same monthly payment as you can’t manage.

Every 3% adds 25% ish to the monthly payment - historical rates are about 3-4% higher than recent rates - so slash 25% off the house prices to keep affordability at todays record low levels…

Course then people won’t be so happy to take in such high debt loads as they’ll be reading the papers full of sob stories about greedy SOB’s who “owned $3M in property and now are bankrupt”.

Although for once the article by Rich wasn’t clear - the general point behind it is - rates are transient - and as such they can devalue your house as fast as it inflatied it’s “value”. The sheeple only care about the monthly payment - that’s why at record low rates we’ve seen such gratuitious asset price inflation - thing is it has the potential to drop just as fast as rates rise.

Comment by GetStucco
2006-02-10 05:11:19

Nice clarification of Rich’s point. These low rates were here courtesy of AG. Now that he is retired, don’t expect the low rates to stick around.

Comment by jeffolie
2006-02-09 15:51:52

mad tiger
jim A

Alot depends on the rate of inflation and/or deflation, if the loan are indexed or fixed, ballon or option ARM and not to mention the currency fluxuations. Simple present value and stream of payments analysis cannot assume all things being equal.


Fed Focus
Paul McCulley
Managing Director PIMCO
February 7, 2006

“…When the cyclical turn comes, it will be a wicked turn, our guts say, as conventional policy gives way to unconventional property market weakness….”


Comment by SunsetBeachGuy
2006-02-09 17:15:23


The link you posted doesn’t go to Something Wicked This way comes. It goes to The Knack for When and the Gift for How.

Could you update the link?

Comment by rich toscano
2006-02-09 15:53:37

You guys are right… I screwed up the terminology. When I was referring to valuation I really meant “expensiveness.” IE, while lower cost of capital increases rental housing “value” the same forces that the lower the cost of capital have tended historically to lower the real price (or expensiveness) of housing.

So while I messed up the terminology I think the thesis is correct. I posted a clarification on the Voice site as well, which included the following paragraph and also removed errant references to “valuation” where I should have said “expense.”

To be clear, interest rates matter. Lower rates do increase an asset’s intrinsic value to some degree, as they increase the “present value” of income derived from that asset. But given that low rates usually accompany tougher economic times, the bump to a home’s intrinsic value is usually less important than the economic climate when it comes to setting an actual price for that home-as the above chart demonstrates.

Comment by JWM in SD
2006-02-09 16:08:05


I wouldn’t worry too much about the terminology as long as the basic point you were making was right. I worked in the automotive component manufacturing industry before moving to San Diego (Mira Mesa) from Chicago, and did a lot of NPV analysis for justifying investment in equipment for new parts. The bottomline was always potential cashflow relative to cost of the equipment. If the investment in equipment (house) was significant, then the potential cashflow (rent less expenses and WACC) had to be sufficient enough to justify the purchase. There was no such thing as acceptable negative cashflows. This is why I’ve laughed for the past year or so whenever I’ve overheard realtors and speculators at the local coffee shop (usually Starbucks in Fashion Valley) calling themselves business men/women. They haven’t a clue.

Comment by Uncle_Git
2006-02-09 16:10:36

It’s the opium smoking that did it - happens to me all the time.

We exchanged a few emails way back when piggington.com first started -
good to see you are still writing intelligent pieces that hopefully will save a family or two some pretty severe financial pain and stress here in San Diego.


Comment by JWM in SD
2006-02-09 16:28:24


I wanted to thank you for braving the critiscm here in Bubble Central San Diego. My wife and I moved here over a year ago since she was stationed at Balboa hospital (naval pharmacist) from Chicago. If it weren’t for your site, I don’t think that I could have convinced her that renting was a better idea than buying in the current market (we’re renting a house right now in Mira Mesa).

Comment by rich toscano
2006-02-09 18:13:54

Thanks guys… (and hi Graeme, good to hear from you again).

This is what happens when you wait til the last minute and write your article at 1:30AM the day it’s due… :-/

Comment by GetStucco
2006-02-10 05:18:41

Rich –

I think Uncle_Git’s post nailed it — these low interest rates are transient, and so are the “values” they support.

Comment by Tako John
2006-02-09 15:54:11

Although for once the article by Rich wasn’t clear - the general point behind it is - rates are transient - and as such they can devalue your house as fast as it inflatied it’s “value”. The sheeple only care about the monthly payment - that’s why at record low rates we’ve seen such gratuitious asset price inflation - thing is it has the potential to drop just as fast as rates rise.

Yes, houses are currently leveraged to a degree that hasn’t been done for 70 years. Leverage becomes vastly more risky when players have little or nothing in the game, and as of now buyers have less than 0 in the game. When everyone has this so-called edge (irrationally easy money) then a bubble can take hold.

Comment by john in md
2006-02-09 15:57:05

The author is technically correct. When you compare a house to a bond (fixed income) then there should be some relationship of the price of the house and changing interest rates. As the cost of money declines, the income streamfrom the house becomes more valuable so there should be some adjustment upwards in the house price. Having said that, the price of most houses in the bubble areas priced as if the owners expect a doubling or more in that income stream (as in the accepting of a higher PE ratio in a growth stock). As the ability to pay rent is directly tied to people,s income, I don’t see the jump in rental income happening.

Comment by deb
2006-02-09 16:05:14

The last property market crash in SoCal (’90-’95ish) is the perfect illustration of the fact that lower rates DO NOT serve as a fundamental for higher home prices. 30 year rates peaked at well over 10% in ‘89 and fell straight through the bust (with a few bumps along the way, but not many). The dramatically falling rates helped to increase affordability all the way down. This time we will not be so lucky, as we are starting with record low rates and record low affordability. All affordability adjustments must come at the expense of price.

Comment by rich toscano
2006-02-09 16:08:56

Indeed… the basis of the article was this chart, which support what you are saying.


Comment by goleta
2006-02-09 16:29:09

That’s what I remember too. When prices are expected to fall, who cares about interest rate any more?
Even when interest rate was virtually negative, you couldn’t make a Japanese to buy a home in Tokyo at already 80% off the peak.

Comment by Robert Campbell
2006-02-09 17:05:30

Absolutely. Real estate trends - like most other market trends - are about perception … and people’s expectations about the future.

Comment by JWM in SD
2006-02-09 16:21:14


Comment by John in VA
2006-02-09 16:25:33

The author is 100% correct. It is a mistake to base your valuation of an asset on interest rates if you expect interest rates to rise during the timeframe in which you will discharge the asset. Using an extreme example to illustrate the point, imagine that today, with interest rates at 1%, you had the opportunity to buy a piece of equipment and, based on your NPV calculations (interest rate and all) you value the asset at $100K — which is $5K more than the asking price. Seems like a good deal. However, you know that you will probably sell the piece of equipment after one year. In one year, you believe that interest rates will be 5% and therefore, a prospective buyer’s NPV calculation will value the equipment at $60K. In other words, you expect to take a $40K loss in one year. As an alternative, you can opt today to rent the piece of equipment for $1000/mo.

Would you buy?

Comment by Roy G Biv
2006-02-10 18:57:53

Using an extreme example to illustrate the point

, Thank you, thank you, thank you !! By the out of wack example it is easier for some of us to comprehend what is going on ! THANK YOU

Comment by hedgefundanalyst
2006-02-09 16:28:06

The article is flawed.

Interest rates do matter because there is always an opportunity cost to buying: rent and investment.

If interest rates were 20% versus 5%, the hurdle for owning a home would be much higher versus other investments because you could easily invest and make more in the alternative asset. Why be the borrower when you can be the lender?

That sort of arbitrage does not last in the long-run and either home yields go up (rent/house price) or interest rates fall (most times a combination of both).

I think people are mistaking the difference between the statement that “interest rates don’t matter” versus the fact even current “low” interest rates cannot justify house valuations in bubble areas.

By the way if you are reading this Deb, though the early 90’s was a difficult time, the Fed cuts DID help mitigate housing depreciation. If the Fed hadn’t cut, prices would have fallen even more. Before the last few years, that period experienced the biggest refinancing boom in history.

Comment by JWM in SD
2006-02-09 16:36:33

That assumes that one is buying the house as an investment though. Otherwise, opportunity cost is irrelevant…you can’t live your google stock.

Comment by hedgefundanalyst
2006-02-09 16:46:14

“you can’t live your google stock.”

No, but you can use your downpayment to buy it while renting. I would know, I was long Google until 400.

Comment by deb
2006-02-09 16:38:52

That was my point, that the prices still fell dispite the rate cuts. I was selling houses then, and believe me, the lower rates helped, just not enough.

Comment by hedgefundanalyst
2006-02-09 16:44:19

Asset pricing is a dynamic process. If one were to regress housing prices, one would see that yield spreads, initial affordability, and employment are the dominating factors in determing house price movement. For housing prices to flatten, you would need 2 out of 3 factors to go against it and for a crash you need 3/3 against.

So why did San Diego and other bubble area prices go vertical from 2000 onwards? Because you basically had 2.5/3 factors working for you during those 5 years.
1) Rapid Fed cuts and a long lasting yield spread that made for easy lending
2) House prices were affordable in 2000 thanks to a combination of a blowout in prices in the early 90’s coupled with stock market overvaluation that kept housing a relatively underinvested asset class in most areas
3) Employment by historical measures was strong througout the shallow recession

Fed cuts essentially put fuel on fire and by 2002 housing was overvalued compared to a normalized rent stream. However, only until the end of 2005 did you finally have 2/3 factors turn for the worse:

1) Gradual Fed hikes have finally taken us to an inverted yield curve and lenders must now scrutinize borrowers more, eventually driving up spreads (risk-premium) for a majority of homebuyers.
2) Housing valuations can best be described as ludicrous
3) Employment is strong and I’ll leave it up to the reader to decide what he/she thinks employment will do going forward because the answer to that question will determine whether we have a “soft or hard” landing.

Comment by sm_landlord
2006-02-09 17:24:50

I think you also need to consider supply/demand as a factor. Your third factor (Employment) that will determine the outcome is partially a function of the supply pipeline vs the uptake of new product coming on the market. If builders cut back due to excess supply, and higher HELOC rates cause a drop-off in home improvement spending, you will see the results in employment, and you’ve got your third piece of the puzzle. The only question in my mind is how strong a factor that will be, because I doubt that layoffs at the builders and at Home Depot will hurt employment enough to make employment more than a .25 factor in general. Of this will vary some by market/region, but it should be felt noticable in the areas that have the largest supply overhang.

Comment by hedgefundanalyst
2006-02-09 16:49:24


I was selling houses then, and believe me, the lower rates helped, just not enough….BECAUSE LOWER RATES COULD NOT COMPENSATE FOR THE INITIAL OVERVALUATION.

Yes, I agree.

Comment by rent2home
2006-02-09 16:52:13

A simple Logic can prove that low interest rate IS NOT THE CAUSE of this mad increase in Housing price.

For buying the same HOUSE, the monthly payment was HIGHER and Went even HIGHER over the years.

All the time when the cheerleaders have been fooling the masses with theory of cheap interest rate.

It is speculation, easy credit avialability, giving credit without checking regular income is the ROOT CAUSE in my opiniuon. Thanks to all of you in this BLOG to have made this clear to me.

Comment by ca renter
2006-02-10 00:52:03

Absolutely correct! This is also why, for those who have cash, a higher-rate/low cost is better than low-rate/high cost. The low rates are a symptom of too much money to lend to too few borrowers. They’ve opened up the floodgates and attracted “anyone who can fog a mirror” into the home buying arena. This is where all the “demand” comes from, and it’s self-perpetuating. People were willing to commit a higher portion of their monthly pay toward their mortgage payments because the house was compensating them for it (and a lot more). Makes sense. As prices fall, houses will be seen for the liability that they are, and people will want to pay less and less of their income toward their mortgage payments. At the same time (hopefully), lenders will tighten their standards further and there will be even fewer potential buyers (those that weren’t already borrowed from the future). Only one way prices can go from there…if only we could know WHEN this will start.

Ultimately, irrespective of monthly payments, would you want to buy an appreciating asset or a depreciating one? I certainly don’t want to be locked into a (depreciating) house for the next ten or twenty (or more) years.

Comment by GetStucco
2006-02-09 16:56:48

“The article is flawed.

Interest rates do matter because there is always an opportunity cost to buying: rent and investment.”

New Yawkers have a hard time with this point, but low interest rates are not an exogenous fundamental factor, but rather an endogenous historic anomaly which was driven by govt policy measures (negative Fed Funds rate, tax cuts, favorable tax breaks for housing, Fannie Mae MBS sales, etc), and which is in the current process of self-annihilation. Don’t feel bad, hedge, some economists at the NY Fed are just as confused as you are by this.

Comment by hedgefundanalyst
2006-02-09 17:24:41


The only thing I am confused about is your jealousy.

Comment by thejdog
2006-02-09 17:44:12

….and may I add his use of words. Take it easy proffesor, class isn’t in session.

Comment by GetStucco
2006-02-10 04:55:20

Sorree abowt that. I will try to dumm doun my posts so you and hedge can understand.

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Comment by KIA
2006-02-09 17:00:00

I think the underlying principle which people are hinting at here is this: when the cost of money decreases (easy credit), people spend more of the easy money. There is no immediate pain to paying $500,000.00 for a house which has a “real” value of $400,000.00 so long as 1) The monthly payments are the same, and 2) there is a perception that value is being acquired, whether in the form of a) real or potential rental revenue stream or b) anticipated appreciation. This is driving the increases in prices, not a real increase in “value” but an increase in the availability of what is being used to purchase the “value” - money - and the expectation that the purchase will ultimately provide more money. This type of scenario, where more money is chasing the same scarce resources, is inherently inflationary because people perceive the easy money in some necessary areas (housing, energy) and demand more for their goods and services. Problem: real wages have remained stagnant. People’s demands for more for their services and labor has been ineffective. This is driving the market further and further out of balance and driving the credit aspects to unsustainable heights. Credit can only be extended so far or it becomes debt which can never be repaid. The borrower defaults. Expectations of revenue stream and appreciation will both prove unfounded as everyone tries to rent out properties at the same time and sheer volume drives prices down, and as this occurs, properties will be losing “real” and perceived value. Nobody remembers that the 1929 crash was preceded by a real estate boom and bust in Florida. We still hear sayings like “I’ve got some great waterfront property in Florida to sell you…” (swamp) but nobody remembers where the sayings came from. In Galbraith’s book, he states that many of the Florida speculators sold land several times and got it back years later with improvements, lights, buildings, and it still wasn’t worth what they sold it for in the first place. This will happen again and again as long as the lessons are forgotten.

Comment by John in VA
2006-02-09 17:29:41

20 years from now, it will be, “…and if you believe that, I’ve got a condo in Florida to sell you!”

Comment by Backstage
2006-02-09 21:05:12

Lots of people remember. I know Getstucco remembers. But, remember, It’s different this time, and (insert your city name here) is different.

Comment by Mo Money
2006-02-09 17:17:19

Employment is strong and I’ll leave it up to the reader to decide what he/she thinks employment will do going forward because the answer to that question will determine whether we have a “soft or hard” landing

Strong Employment doesn’ t mean much if the jobs pay below median income. Even at Median income Silicon Valley has priced most people out of the market. There is currently little hope of buying a detached SFH home here and even purchasing a small condo is questionable without a suicide loan. Wages have been relatively flat since 2000. So either the prices come down to meet the wages or the employers double my salary. I don’t expect the latter to happen.

Comment by bluto
2006-02-09 17:36:32

Actually, I think the recent rates did have something to do with the bubble, but it isn’t the normal theory (low rates->low payments->higher asset prices).

Low rates following a stock market crash left a whole lot of investors scrambling to get yield of any kind just as the economy was picking up steam (and lenders bought wholesale into credit ratings just as borrowers figured out enough to know what factors help and hurt your credit rating). So you have way to much capital headed to the subprime markets (not just in housing–emerging markets, junk bonds, almost every high risk asset class is at record low spreads from investment grade assets.

Also, there are two components to a home’s value. Rent savings which is the pure mathmatical discounted cash flow calculation, and an intangible I’ll call ownership pride. Most people would prefer to own vs rent if costs were equal so there is some premium to owning a house. My speculation is that housing stock was essentially flat, while perhaps 20% of the buyers found themselves suddenly able to buy a home in 2002 or so, and they bought like crazy (having seen house prices generally move up over the long term). Their initial purchases led to speculators becoming attracted to the asset class and well now we have ghetto clapboards with “granite countertops” selling for $300+/sqft. W00t!

Comment by sm_landlord
2006-02-09 17:48:37

Good idea for another thread - try to define what bluto calls “ownership pride” - the premium that buyers will pay to:

1. Own a living space that they would otherwise rent
2. Live in a space that is built better than a cheap apartment
3. Live in a SFH with no connected walls rather than shared walls and structure, perhaps including a few square feet of land between them and their neighbors.
4. Live in a house with at least a quarter acre of land surrounding it.

These four items are probably a bit more than Bluto meant, but I think that they are the factors that drive people to make rent/buy decisions, since some of these options are only available to owners under most circumstances. They might be a fifth consideration for dedicated urban dwellers, and that would be the prestige factor of owning a penthouse in NY or a beachfront in Malibu. But those considerations are not a factor for the vast majority of buyers, so I mention it only in passing.

Comment by Mole Man
2006-02-10 03:21:00

Regarding the last two points:

3. Live in a SFH with no connected walls rather than shared walls and structure, perhaps including a few square feet of land between them and their neighbors.
4. Live in a house with at least a quarter acre of land surrounding it.

These do not have a strong relation to the housing bubble as it really is because much of the action has been with condos, townhomes, and small homes offering urban living. Cost is the main issue. Control is complex because some of the CC&Rs on new construction impose more restrictions than would typical landlords.

Comment by ajh
2006-02-11 05:09:43

5. Own a property that you believe at some point will appreciate.

I agree, an excellent topic idea.

Comment by hedgefundanalyst
2006-02-09 18:34:05

Bluto, I am basically in agreement with you but I think that ownership pride gets diluted with downpayment hurdle, transaction costs, rental flexibility, maintenance headaches, and natural economic stress.

Those things considered owning a home should cost less than renting, but “ownership pride” is what makes them equal the same.

Comment by sm_landlord
2006-02-09 18:59:49

Hedgefundanalyst mmake a good point here in passing, so I would like to emphasize it through restatement.
“owning a home should cost less than renting”/i> is a bigger deal than it seems, because the owner takes on the liability, has the actual money at risk, is responsible for the repairs, code compliance, fire, earthquakes, yadda, etc. There has to be a serious economic return for all of this.

People (and the current market) seem to ignore this important point. In a reasonable world, it would cost *more* to rent a given property than it would to own it. Substantially more.

Stuff that into your rental price pipes.

Comment by bluto
2006-02-10 05:24:15

There are ownership risks, but there are other risks associated with renting that stirs strong emotions in people. I think in most people’s risk calculation, the risk that you will have to make an unwanted move on relativly short notice is a primary factor (even if that risk is exceedingly low). Also, I think many people are looking at the inflation risk transfer (implicit in a 30 year fixed rate loan with no prepayment penalty-that has quite a bit of option value for a spread of about 120 bps over swaps) as a major secondary factor. I find it more than a little ironic that the action taken by many homeowners in response to this wealth transfer is to retain all of the inflation risk.

I think all things being equal almost everyone would prefer to own a home and some land to renting, but I cannot describe accuratly why this is given that you are correct homeowners generally take on more risk than renters (espeically under a long term lease).

Comment by GetStucco
2006-02-10 05:26:57

“Rent savings which is the pure mathmatical discounted cash flow calculation, and an intangible I’ll call ownership pride.”

I don’t disagree with this — I feel that way myself about being a renter. However, one component of ownership pride, the part that takes satisfaction in knowing how rich you will be after living in your home for a couple of more years, is soon to give way to ownership consternation at falling prices.

Comment by sm_landlord
2006-02-09 17:39:24

I am not an economist; but inexpensive loans, coupled with a consuming public that has been trained to see purchase prices only in ters of the necessry payments on the attached financing, are pretty much the modern definition of inflation.

When a bank loans money on fractional reserves, I think we all agree that they are basically manufacturing money. When the government settles international trade accounts into a deficit, they seem to be manufacturing money. When dollars come back from our trading partners abroad, it likely that they are buying discounted future cash flows in the form of MBSs, among other things such as treasuries.

What I don’t know is how to put a number on all of this new money. I do know that monetary inflation is happening fast, and that it has not yet shown up in broad price inflation, although you can certainly see it inflating housing prices, commodities, etc.

The questions are, how much of it is there, and where is it going next?

Comment by cactus cody
2006-02-09 18:07:33

Zillow is a joke. It’s like a newbie RE agent.

Comment by thejdog
2006-02-09 18:19:54

I wouldn’t go as far as saying that Zillow is a joke…well maybe their projected property values are, but with a rapidly declining market there is really no way for them to get it right. Much of their projections are base on YOY apreciation rates. With values increasing at a steady rate over the last 5 years, it would’ve been more accurate. Much less of a tool in a bear market IMO

The only thing new thing Zillow brings to the table anyways is a good interface, as the information they give as far as comps, which are the only thing that is of value, were already available from Domania.com.

Comment by GetStucco
2006-02-09 18:20:22

“The only thing I am confused about is your jealousy.”

I guess it shows — I am just dying to move to New York City.

Comment by hedgefundanalyst
2006-02-09 18:28:05

I’m not dying to live in NYC either. My family and I are quite happy in Greenwich, thank you very much.

Comment by skeptic
2006-02-09 19:12:14

speaking of Greenwich, am I wrong, or has the inventory exploded there this month?

Comment by GetStucco
2006-02-10 04:52:59

Too close for comfort…

Comment by DC Bubble
2006-02-09 18:35:39

For DC zillow only shows assessed value not the last sales price, though assessed values have been going through the roof in DC too.


Comment by crisp&cole
2006-02-09 18:40:29

100 net new listings this week in Bakersfield! There is gonna be blood in the streets!

Comment by John in VA
2006-02-09 19:20:01

Homebuilders in Bakersfield are teaming up with PG&E to offer free toxic chemicals to the first 100 homebuyers. You don’t even have to turn on the tap water to get your daily supply of hexavalent chromium. Saturday only!

Comment by bubble_contagion
2006-02-09 19:06:14

Some San Diego numbers for January are already out. Sales plunge -31% from December, -27% compared to January 2005. In some areas, like Carlsbad, sales dropped -55%. Prices are holding and increased by 2.5% compared to December 05.

The info for central san diego is here:


All others:

All areas

Comment by GetStucco
2006-02-10 05:32:15

“Prices are holding and increased by 2.5% compared to December 05.”

Those prices provide an upwardly-biased picture of current market values. Most of the price information is hidden in the growing pile of used home inventory.

Comment by feepness
2006-02-10 06:37:27

Stucco, is right, only the good stuff moves, making the median go up slightly… before it dips.

The interesting thing is that in my area (North Park) while I am seeing a lot of open house signs on Saturday/Sunday trying to create traffic I am seeing FAR FEWER for sale signs on my walks in the nearby neighborhood.

Of course there is a lot of fixing up still going on and these people may be planning to sell in spring or we may simply have ended up with families in my walking area. I’ll know more as walking/jogging season has returned.

Of course the 100s of condos are still going up…

Comment by DC Bubble
2006-02-09 19:27:41

in dc the market sure feels like it is bifurcating. single family house in ho neighborhoods still get multiple contracts and sell for the asking price if not slightly higher. condos on the other hand….

for the complete story click here:

Comment by John Law
2006-02-09 20:05:35

The U.S. is not alone in destroying the purchasing power of its currency. Since the inception of the Euro, the E.C.B. has expanded the money supply by an average of 9% per annum and Asian nations are constantly busy diluting their monetary bases as they try to keep their currencies from rising against the dollar. The result? All this money needs to find a home; fortunately for the U.S., for now a good deal of that cash ends up in our bond market. So, in a perverse anomaly of economic principles, inflation is keeping the yield on treasuries artificially low. This situation cannot last indefinitely, however.


there is your conundrum.

Comment by nhz
2006-02-10 02:03:17

good point, and I’m surprised how many posters here totally ignore this. I cannot imagine the US housing bubble will end with EU interest rates at four-century lows and no sign that they are increasing.

Yes, the ECB increased interest rates with a tiny 0.25% recently but - SURPRISE!! - mortgage rates and interest paid on savings accounts went DOWN 0.5% shortly after that (currently 4% for a 30-year fixed mortgage, in the Netherlands that’s effectively 2% for a 30-year fixed). The 0.25% ECB rate increase is a scam just like al the ‘tough talk’ from Greenspan about fighting inflation.

Comment by ajh
2006-02-11 05:15:39

nhz writes from the Netherlands, but if you want to see somewhere where the RE market has gone absolutely nuts because of low euro mortgage rates, check out Ireland.

I have seen articles stating the average price in Dublin is higher than London; now despite the strides the Irish economy has taken in the last few years that’s truly crazy.

Comment by nhz
2006-02-11 12:54:10

yes, I have heard that as well - probably part of the cause is the huge amount of EEC development subsidies flowing into Ireland. According to The Economist, the (average) (over)valuation of homes in the Irish market is still lower than in the Netherlands; it is very difficult to just how excessive prices are.

(Comments wont nest below this level)
Comment by cereal
2006-02-09 20:20:47

raise the price of cap’n crunch????

oh great, so next is the cereal bubble.

Comment by Pam
2006-02-10 01:04:13

Cereal: You have got the best one liners I have ever seen here! I can always count on you to lighten things up! But thanks to you and everyone for teaching me so much!

Comment by Backstage
2006-02-09 21:11:19

Thanks everyone! Fre me this is one of the most interesting reads of the past few months. It does a great job of tying the credit bubble to the housing bubble.

And, as always, thanks, Ben!

Comment by punktilious
2006-02-09 21:32:55

Ahhh. But wait, the cereal bubble actually occurred before both the stock bubble of the 90’s and the real estate bubble of the 00’s. Keep your eye on cereal. Bloomberg just added cereal to their list of commodities last week.
cereal futures man. :)

Comment by scarlett
2006-02-10 00:24:27

I think you might want to read the article at its original source. An update was made since Ben posted – it clears up a lot of what’s discussed here. It also has a fancy graph.

Comment by scarlett
2006-02-10 08:27:49
Comment by AmazedRenter
2006-02-10 05:34:38

I am pleased. Zillows shows that prices in my zipcode (Bellevue, WA 98005) have dropped 2.3% in the past 30 days. All price graphs show a typical top pattern (and are now descending).

I like Zillows. Many people will use it as it’s much easier to access than public records. Websites like Zillows could reduce speculation: Why pay 50% more for a house than someone else 1 year ago?

Comment by jm
2006-02-10 06:28:19

“If one treats a home as an investment, and it seems very clear that most San Diegans do view their homes as investments, then the cost of financing that investment is irrelevant.”

“Now that rates have risen … does this imply that home prices should have declined? …”

Although the cost of financing an investment is highly relevant, and stock and bond prices are directly affected by interest rate expectations, lending to stock and bond market investors is much more tightly regulated than mortgage lending. If any company started handing out IO or neg-am loans for stock or bond investing, they’d be shut down in a flash. Nor would they be allowed to make the equivalent of 80/20 or 95% LTV mortgage loans. Retail investors must put up at least 50% margin (=down payment) on any stock purchase, and the brokers by law must make clear to them that if the stock price falls the entire drop is subtracted from their margin, and if their margin ever falls below 50% they must immediately come up with more margin or face having their stocks sold for the current market price.

What is driving prices to insane levels is the buying power being put in the hands of incompetent investors by lax lending regulation. No one would be allowed to speculate in the stock or bond market with the kind of highly leveraged loans now being made for real estate.

Comment by DC_Too
2006-02-10 07:35:37

This is a most impressive thread, though somewhat overwhelming to the average Joe like myself. I am inclined to point out that my last primary residence purchase, in 1997, was funded with a 15-year, fixed rate loan at about 7.5%. Not too shabby.

Attention here seems to be focused on rates. What is missing is the AVAILABILITY of credit, for Heaven’s sake. In my situation, above, it was an out and out battle to get a mortgage loan. At the time, banks had been badly burned by bad loans, and were reluctant to lend, even under circumstances that met their standard underwriting criteria.

That is not to say calculations put forth in this thread are invalid, of course, but when the money dries up, home “values” will suffer terribly, as even those potential buyers are are “willing and ready” shall find themselves “unable” to borrow. Prevailing rates of interest won’t really matter, as fear impacts bankers just like the rest of us.

They trip over one another to lend at the current 4%, but it is a near certainty they and there bond market backers will slam the vault shut when they can get 12%.

Comment by KIng_Cheese
2006-02-10 10:01:22

There is a logical flaw in this article. It assumes that demand for stocks and real estate are influenced by the same factors. They are not. The key difference (as far as this article is concerned) is that lower interest rates increase the demand for real estate, while lower interest rates do not affect demand for stocks.

Therefore, when interest rates fall demand increases immediately, while the increase in supply takes more time. Thus resulting in temporary price increases that outpace inflation. It is not until supply catches up with demand that prices revert to the mean.

OT. However the dirty little side effect is that by the time supply catches up with demand, the interest rate cuts that boosted demand have dissipated resulting in a housing bust.

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