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A Penny For Your Thoughts - On Second Thought You Better Make That A Dollar

A Penny For Your Thoughts - On Second Thought You Better Make That A Dollar by Bill Roberts

I recently read an article by Matt Heaton explaining the role of the Fed on interest rates: Why does no one in the media understand The FED?

I wrote my own take on this: Greenspan, The Evil Villain

Home Prices

But it doesn't matter which one of us you believe, the fact of the matter is that interest rates affect home prices.

Some people think that the recent (2002 - 2005) run up in the price of a single family residence was some kind of conspiracy.

If there was a conspiracy it extended all the way up to the Federal Reserve Board because the price of a house can be demonstrated to be a function of the monthly payment (on the mortgage) and that is a function of the interest rate on a home loan. When the Fed ran the interest rates down to zero, the corresponding bond rate for a Fannie Mae loan package was also at a very low rate.

The average buyer, whether for big screen TVs, new cars, or a house makes his decision based on his ability to make the payment, not on the price.

In the final analysis "price" has nothing to do with the price.

Money has everything to do with the price:

The cost of money
The availability of money
The future expectations of money

So if there was a conspiracy to drive home prices up, it was manifested by the Fed. As they drove interest rates down, they drove home prices up. I thought they just wanted to stimulate the economy!

People have written whole books on interest rates, prices, and inflation. I don't think that I can do it justice here. Suffice it to say, we have an abundance of "money" and the Fed wants to use "money supply" to control price level.

They "manipulate" interest rates as a means of controlling money supply. Right now they would like to raise rates in an effort to reduce inflation (which is how they refer to increases in price level). But it won't work. At some point they will want to stimulate the economy again and interest rates will come down.

Law of Unintended Consequences

And sooner rather than later because according to the law of unintended consequences, the higher interest rate has actually increased the money supply. Lower interest rates in Europe and Asia can't compete with our rates so all the free money flows into our banks. We have too much money. Inflation will soon follow. The only way to fix it will be to lower the interest rates again.

So what does all this mean? It means that our slump will end soon. Home prices are still going to go up. Not because "demand" is going to increase. Not because houses are going to become scarce. But simply because people will be able to borrow more and still be able to afford the payment.

Whether or not we have sub-prime loans, housing will become more affordable with lower interest rates. Underwriting standards will be "relaxed" again in order to lend out all the available money.

We will not have a repeat of the "mortgage market meltdown" because we learned a thing or two this time. Investors will need to put some skin in the game. No more 100% financing for non-owner occupants. Pay option ARMs will still be available, but borrowers will need to qualify at the fully amortized, fully indexed payment amount.

All in all, good times are coming. If I was a Democrat I would sing "Happy Days Are Here Again." I just might sing it anyway.

Are you ready?

Call Bill Roberts for help with your Real Estate Investment needs at (619) 244-4610.

Posted by Bill Roberts - "Baby Boomer" Retirement Planning on 01/08/2008 05:18 PM

Comments (10)

bill roberts real estate, investment real estate, real estate investing, baby boomer retirement planning

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10 Comments on A Penny For Your Thoughts - On Second Thought You Better Make That A Dollar

JAN

2008

Well written, Bill.

Jason, thank you.

Bill Roberts

Not so sure how you can conclude that "Home prices are still going to go up"?

I think the housing market is midway through its severe bear market, if not more. Residential real estate will bottom in price either this year or, more likely, in the first half of 2009. The number of housing starts has collapsed, and inventory is at multi-decade highs, which are both prerequisites for a bottom.

However, housing is an illiquid, discrete market, unlike the stock market, which is liquid and continuous. Thus, the bottom may take longer in housing simply because it takes longer for sellers to adjust their expectations downward. Therefore, the duration of the correction may last longer than I anticipate.

Banks are just beginning to liquidate their inventories of foreclosed homes. As foreclosures pile up, banks will sell properties below par, in some cases substantially, to jettison properties off the books.

Forced sales are beginning to occur, with Lennar (LEN) selling several thousand units well below book value. Anecdotally, I know of one bank in my state that sold property for $0.30 on the dollar. My gut says that forced selling will accelerate, and the market will not bottom until it peaks...and we're simply not there yet.

The downturn in commercial real estate has just begun. It will not be as long nor as deep as the bust in residential real estate since there was not as much over-building. Nonetheless, at the height of the frenzy, loans were written at ridiculous terms. The values of those loans are deteriorating, which is restricting credit in commercial real estate and causing a decline in the value of commercial property.

Beyond the problems wrought by poor underwriting standards, the value of commercial real estate is dependent on the state of the economy. If the economy avoids recession, then the downturn in commercial real estate will be manageable. If the economy slips into a significant recession, look out below.

Paige, I realize that you are in FLA. Things aren't as bad here in San Diego. As for the propects for recession it is very hard to call. Recession can be avoided or postponed if the Fed so chooses. But who can make that call?

My guess is that the Fed will come down on the side of no recession. Interest rates will come down. "Affordability" will increase. Consumer confidence will rebound. And prices will increase.

But it is all just my guess.

Thanks for taking the time for your well thought out response.

Bill Roberts

I tend to agree with you, I got a call from a mortgage broker today saying rates were 5.5% for a 30 year fixed. But with rising home prices and wages not increasing there is still going to be a lot of people left out of the market, who still won't be able to afford the American Dream

Michael, The FNMA 5.5% bond is trading at close to par. That means 5.5% is available to the best borrowers, but I think rstes will come down some more.

Thanks for commenting.

Bill Roberts

Bill: Well, of course your are right about the interest rates... they will have to go down. The prices on median sized homes are still going up in my area.

I guess we could call our friend, the well-known "wacko alchemist" Greenspan and ask for his opinion... (wacko-alchemist is not original with me... I read it somewhere) Get him on the phone, put him on the speakerphone!

Jan, In some ways we would be better off with Greenspan right now because I really believe that he would keep lowering rates until he got what he wanted on inflation (which is his biggest bugaboo).

The important thing is consumer confidence. with that the buyers will be back.

Thank you for your thoughts on this.

Bill Roberts

JAN

2008

Exactly. I just wrote a quick blurb recently along that very line with the FHA Modernization Act. People will buy houses when they can afford the monthly payment and borrow money. Plain & Simple.

Jen, you are right, it is plain and simple. Thank you for commenting.

Bill Roberts

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