It is always interesting to see to what lengths pro-Bush supply siders will go to in order to deny the existence of problems in the U.S. Economy. Just take Alan Reynolds’ latest townhall.com article.
In it,he attacks those of us who believe in a housing bubble and more specifically Morgan Stanley economist Stephen Roach. First he attacks a straw man version of Roach’s argument, when he quotes Roach as saying that the bursting of the housing bubble will be worse than the bursting of the equity bubble by saying this would have to mean that housing prices would have to fall 80% like NASDAQ did. Which of course is not what Roach meant. As the housing values are so much greater than the NASDAQ market capitalization ever was, a much smaller decline in % is required to produce the same loss in dollar value.
Next he claims that the rise in housing prices is not something to worry about since housing debt has not increased faster than housing values. But that is only true in comparison to the record high leverage that was reached in 1999 and that reflects the enormous price increases. Relative to disposable income , mortgage debt has increased sharply from the already record high levels in 1999, from 65% to 84% in the third quarter of 2004 (Total household debt has increased from 94% to 115% in the same period).
His next line of argument is that the talk of a national housing bubble is meaningless since prices has increased much sharper in some areas than others. But that prices has increased even sharper than the average in some areas is not something which should make this seem like less of a bubble. To the contrary it probably (though not necessarily as the relative price movements could reflect greater attractiveness of some areas) reflect even greater imbalances.
In the end of the article, Reynolds wonders what could burst the bubble. Well, what is it that bursts bubbles in general? Usually it is a combination of buyers losing faith as prices becomes to unreasonable and require so great amounts of money that they neither can nor want to borrow more and is unable to pay for it with their income as well as a increase in interest rates. Reynolds argue that interest rates will only rise if inflation rises and higher inflation is good for housing prices. But the point he misses is that real interest rates have been at record low levels during the last few years (real short-term interest rates have actually been and still is negative). When real interest rates move up to normal levels, interest costs will become so high that households will be forced (particularly given the current non-existent savings) to stop their bidding up of housing prices. Indeed, Reynolds earlier in the article actually tries to justify the bubble with the record low interest rates. But if interest rates return to normal then so should housing prices relative to disposable income something which would mean a 25% relative decline from current levels.
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hey, look on the bright side. at least he isn’t saying that people who claim housing is a bubble are terrorism supporters.
given that 90% of total housing related debt is fixed rate, the cash flow implications of interest rates returning to “normal” are modest. By contrast here in Britain where the lending cabal continues to ensure that the borrow takes all the volatility risk, the impact is already being felt.
As for the “not saving” issue – essential to the doom and gloom school, the savings ratio is well known to be a flawed measure of savings – notably through its treatment of capital gains – as an alternative we can look at the Fed flow of funds data which shows a net addition to financial assets of $870bn in q3 (annualised).
Saving is for precaution, deferred consumption or speculation. Home ownership involves all three but initially the first two. Losing your job or retirement are easier if you can meet that part of consumption required by shelter – a house is part of your pension in that it represents deferred consumption of shelter. If there is a bubble it would be in the third – house price speculation. The wider spread implications of a busrt bubble here are different – it would actually help those looking to acquire property for pension and precaution reasons and leave those already owning them indifferent. It would hit speculators and arguably free up capital for more productive use – though there is absolutely no evidence that there is a lack of available investment capital for corporates (not least since it is mostly internally generated).
Mark T, where are you getting your data from, Bill O’Reilly? Variable-rate mortgages make up about a third of all mortgage debt issued for residential purposes, so there is going to be some impact of interest rates on prices.
Besides, not all of this price appreciation is generated solely by low borrowing costs. A lot of it is based on speculation. People buy at higher prices because they think that prices will go up even higher within the next few years. How many of your buddies never talked about investing in real estate a few years back who now fancy themselves as the next Donald Trump? All these new players in the game who buy not to live in a place but as an investment are driving up prices based on very optimistic forecasts of future price appreciation.
When I comment on what someone has written, such as Mr. Roach, I use actual quotations. Stefan Karlsson didn’t quote me because he’d rather put words in my mouth — his, not mine. The bubbleheads rarely even explain what it is they imagine is going to happen to housing prices and why they think it matters. Lower prices would be bad for sellers and good for buyers, but most homeowners can choose when to sell. If your house went up by $50,000 in one year then fell by $50,000 in the next, that doesn’t matter if you’ve lived there at least a year. In any event, this is clearly not a national issue.
Alan Reynolds-while I didn’t formally quote you, I gave a link to your article. And I don’t think anyone reading it think I misrepresented you arguments. And it seems you do not have any counterarguments to the arguments I made.
As to what will happen-well, since prediction about exactly how much house prices -or any other kind of price- will change and when is impossible I will not try to do so. But I can say that I do believe that house prices are way above levels that can be justified by the underlying value of houses. Which mean that house prices is likely to fall. Something which will create problems for the many households whose houses are highly leveraged.
I never denied that existing home prices were likely to fall in the most inflated areas, where new housing supply has been tight. What I doubt is that “many” households have, in fact, highly leveraged their homes at prices near the peak. The vast majority of mortgages are old rather than new. The discounted present value of assets usually rises when interest rates fall. And interest rates are still low (and house prices high) in most of the industrial world. The U.S. as a whole (with notable exceptions like Naples FL) has been a relative laggard when it comes to higher home prices.
With the benefit of hindsight, was Alan’s claim (“The vast majority of mortgages are old rather than new.”) correct? My intuitive impression is/was that refinancing and home equity loans had been popular enough to keep many mortgages in the “new” category.
Almost all subprime loans, more than 90%, were for refinancing. And that very often meant getting a bigger loan to either repay auto and credit card debt (which is smart) or to buy more goodies (which is not). That’s why many subprime loans went to prime borrowers, who didn’t want to put a dime down. Home equity lines of credit can likewise be abused, but I’m not sure how common that was. Still, most of us put some money down and our mortgages predate the peak of 2006. Although 16% have mortgages that exceed the market value of their homes, that is only true in the ten worst states –notably CA, NV, FL, AZ and MI. I’ll provide some data soon, so watch under my bio at cato.org
The link to my article “The Foreclosure Five” is here–
http://www.cato.org/pub_display.php?pub_id=9994
Data showing the U.S. housing prices rising relatively slowly in the U.S. 2000-2006 compared with Sweden, the UK and others will be in National Review’s print edition, late April ’09.
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