The SanityPrompt

This blog represents some small and occasional efforts to add a note of sanity to discussions of politics and policy. This blog best viewed with Internet Explorer @ 1024x768

Thursday, December 23, 2004

The Meltdown Cometh, Part II: New home sales plunge unexpectedly in November

A recent article from Money magazine should have anyone who recently purchased a house or increased their debt load concerned, particularly those who have loans that do not have a fixed rate such as most home equity loans.

Why should someone care about the housing market if they aren't planning on moving right now? Well, because a good deal of consumer spending over the last few years has been driven by perceptions of an increase in home equity. People felt wealthier so they saved less of their income and in many cases borrowed against their home equity. Most people who have looked at the housing market, particularly in major urban centers like LA, SF, NYC, Boston, Seattle, Denver and other places have commented that the recent escalation in asset prices is remarkably similar to that of the stock market at the end of the 1990s.

Good ol' Maestro Greenspan has been telling us not to worry, (after all he did such a great job with the stock market buble so we should probably listen to him right?) that there is no reason to think fundamentals don't support the rise in house prices. But it defies logic to think that housing prices hadn't risen precipitously fast in recent years or to fail to recognize that so much of this increase has been driven by the Fed's efforts to revive the economy by setting the FedFunds rate at unprecendented low levels. Low interest rates make the monthly payments on a home, the key factor affected how much house people buy, much more affordable. At their lowest, fixed 30 yr rates reached about 5%. On a $300,000 home that's a monthly payment of about $1,600. If rates go to 10% (nearer their historic average) the monthly payment rises to over $2,600. It hardly takes a genius to see that the Fed's recent moves to increase short term rates will put upward pressure on mortgage rates, meaning that people will be able to afford less house, and hence, will be willing to pay less for housing.

The economic implications for this are of more serious concern than just pushing down home prices. If a fall in the housing market dampens consumer spending (after all, declining house prices mean less home equity to borrow against), then the economy goes with it. One possible benefit is that declining consumer spending will reduce the American appetite for debt and for foreign goods, but I wouldn't count on our trade situation improving soon. So together with the fall in the dollar, Americans will soon find themselves much worse off. And if an increase in home equity loans and other interest rates puts too much pressure on that record debt over-hang of American consumers, we could see an increase in personal bankruptcies. And we know how personal catastrophes can snowball in recessionary environments. At least those of us who studied history in school do . Did you George?

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