Interest Rate Roundup

Thursday, November 16, 2006

Falling home prices bad? Depends on your perspective

After re-reading my post from yesterday, I did some more soul-searching/thinking about falling home prices. Are they bad? Should policymakers (whether at OFHEO, the Fed, or somewhere else) do all they can to keep them from dropping and/or try to cushion the blow?

Philosophically, I don't think so. Policymakers basically ignored rising home prices on the way up, considering it "asset" inflation not "real" inflation. That, in turn, forced borrowers to stretch themselves to the asbolute max, with the riskiest possible loans, to buy. Speculators jumped aboard the band wagon and took on huge amounts of economic risk in exchange for the promise of big profits.

As we know, things didn't work out. My first reaction is "Sorry, but them's the breaks." If I buy a stock, taking on the risk with my eyes wide open, my analysis proves incorrect, and the stock falls, I lose money. Why should it be any different when anyone else buys a house as an investment?

Now clearly, falling home prices will leave buyers who purchased at the top in the lurch. But think about the BENEFITS of alling home prices, too: They make it easier for REAL buyers to buy homes they can REALLY afford. The fact is, this bubble pushed homeownership out of the reach of countless Americans who were unable or unwilling to commit financial suicide and borrow 60% of their gross income at a 100% LTV to buy a home that costs more than twice as much as it did three years ago. If we're going to have a normal market again, we need normal homes to be affordable to normal people.

Here's a shocking fact: 30-year fixed mortgage rates have steadily declined from a monthly high of 18.44% in October 1981 to 6.31% this September, according to my Bloomberg. But because median prices surged so much during that time period (to $219,800 from $66,000), it actually costs MORE per month to buy a home now than it did when rates were almost three times as high. Assuming you put 20% down, you'd have to pay $815 in principal and interest in 1981 to buy a home vs. $1,090 now. That's the ultimate, unspoken fallout from unchecked home price appreciation -- and why the unwinding of the housing bubble, while painful in the short term, will get us back on the right long-term track.


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