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Guest Post: How Increasing Inflation Could Affect Housing Prices - Correlating Mortgage Rates And Housing Prices

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Submitted by Taylor Cottam of EconomyPolitics

Correlation of mortgage rates with real housing prices: how increasing inflation could affect housing prices

I was talking with a friend who was telling me that it was the absolute
perfect time to buy a house because housing prices have tumbled and
interest rates are low.

I asked him, "What happens to housing prices if there is inflation and
rates go up?"

"Housing prices should go up with inflation as they do for all goods.
Housing is a natural hedge for inflation"

Did my friend have a point? Yes and no.

Yes, he was right that in a high inflationary environment, housing
prices should rise with all other assets. Rents will go up, as will the
price of all the inputs into housing such as lumber and labor costs.

Obviously, housing prices will go up to reflect this reality.

But no, when inflation and thus nominal interest rates increase, housing
prices tumble. When rates fall, housing prices tend to increase.

Relationship between mortgage rates and housing prices

You can see an obvious correlation by looking at the following graph of
interest rates and the log of real housing. The two black circles are
areas where the correlation is obvious. The third red circle is an area
where the correlation seems less relevant.

30 year fixed Mortgage rate and change in real home appreciation
from 1970 to 2006

The simplest explanation for this correlation comes down to payment.
Most people have to finance their homes. As such, they make housing
decision based upon monthly payment, i.e. what they can afford. If a
borrower with 2,000.00 available per month for a mortgage, they could
afford to finance about $372,500 over 30 years with a 5% rate. If that
rate were to increase to 10%, the amount they could afford to finance
would drop by almost 40% to $273,000.

From 1982 to 2003, there was a long term trend of dropping mortgage
rates. During this same term, we had a general improvement in the change
in housing prices. The exception was 1990 to 1991 where there is a
period of negative changes to housing prices that aren't explained by
the mortgage rates. Also, from 2003 to 2006, mortgage rates stabilized,
but housing increased dramatically. New products such became popular
such as subprime mortgages and payment option arms that allowed lower
payments so people could afford more housing and thus drive up the price
even while mortgage rates were stable.

But just how quickly do prices react to changes in interest

We did a regression analysis of interest rates and real housing prices
over the last thirty years. When we do a year over year analysis while
looking at the change of real housing prices over the same timeframe, we
get no correlation (see table). When we took a look at the data with a
lag, we get more interesting results.

For the mortgage rate information I am using Freddie Mac 30 year
fixed mortgage rates
. I am taking the average rate over the course
of one calendar year. I use the change (or log) of the mortgage rate in
the regression. Because it is averaged, the functional rate is close to
the middle of the year. For housing data, I am use beginning-of-year real housing pricing
data from Shiller
. Then I take the change (or log) of this figure.
Keep in mind that we are looking at real housing prices less inflation.
If you looked at nominal rates in a high inflationary environment,
prices might be nominally stagnant, but the real prices might actually
have dropped.

As we are using middle of the year mortgage rate data and beginning of
year housing data, a 1 year lag in the data is actually closer to a 6
month lag. And a comparison of year to year data would be middle of year
mortgage data with beginning of year housing data. Thus, a comparison
of year to year data should be statistically insignificant and that is
exactly what the results show.

There are other reasons to believe that the changes to the interest
rates would not immediately transfer to home prices. Indeed, we found
that the lag could be up to three years (2 ½ years). This could be
partially explained by the following:

  • Real Estate market is illiquid as selling a home can take
    several weeks if not months.
  • Appraisal values are based upon sales price comparisons which can be
    several months old.
  • Financing a purchase of a home could be difficult if sale value is
    significantly above appraisal value
  • Individuals may be inclined to wait rather than sell if the
    neighbouring homes sold for more.

With a one, two and three year time lag, all give us significant
results at the 90% level. Only year two gives us significant results at
the 95% level. Year 1 and Year 3 are very close to the threshold of
being significant at the 95% level.

Regression results of Changes of Real Housing prices against
changes in 30-year Fixed Mortgage Rate

Years Housing Lag Coefficient Intercept R^2 (% Explained) Significant at 95% Significant at 90%
1972–2006 No Lag -0.022 0.018 0.002
No No
1972–2005 1 year -0.149 0.018 0.109
No Yes
1972–2004 2 years -0.182 0.018 0.174
Yes Yes
1972–2003 3 year -0.142 0.021 0.103
No Yes

Regression Analysis

The coefficient is the calculation that would be used to forecast
housing price changes based solely upon interest rates. For example,
using a housing lag of 2 years (1 ½ years ), if today there were a 100%
increase in mortgage rates (5% to 10%), we would expect a housing drop
of 16.6% (-.182+.018) in year 2. The R-squared is the
percentage of the change that is explained by the mortgage rate change.
If R-squared were 1.00, then 100% of the changes to the housing
prices are explained by changes in the mortgage rate. A figure of .174
means that less than 20% of the changes of the housing prices are
explained by the changes in the mortgage rate. In other words, there is a
lot of other factors which combined are even more relevant than just
the mortgage rate.

Why is R-squared so low?

The previous graph shows that when there are large changes to the
mortgage rate, the relevance is much greater than the R-squared
we calculated. Mortgage rates being stable allows other issues
dominate. If there were a large scale increase in inflation (say from 1%
today to 6% three years from now), that would increase the nominal
mortgage rate from about 5% today to 10% credit spreads being equal. The
R-squared, or significance would likely shoot way up.

How do we use these numbers?

With an R-squared of .174, less than 20% of the change is
explained by the mortgage rate. Consequently, I would not use the
coefficients and intercept to forecast when there are small changes in
the mortgage rates as other factors would dominate. What I am most
concerned about is a large scale increases in inflation and how this
would affect real housing prices. In the case of large scale increases,
forecasting using the coefficients would be acceptable as the mortgage
rate would dominate.

Adding the effect from multiple years

While using the data with a 2 year lag is the only dataset that is
relevant at the 95%, years 1, 2 and 3 are relevant at the 90% level. The
coefficients and r-squared values suggest that changes to housing
prices come slowly over time as a bell curve with the majority of the
changes coming in year 2, but significant changes also occur in years 1
and 3.

One way to capture the effect of multiple years would be to simply add
the coefficients from years 1, 2 and 3, in which case we would get a
coefficient of -0.473. However, given that there are different R-squared
and different levels of significance, it would be a challenge to know
the level of confidence we would have in our forecasting. Also, I would
not be comfortable using data that did not have a higher significance

The more proper way to capture multiple years would be to take the
product of the changes over three years. If we regress that dataset
against the changes in the mortgage rate we get a dataset which captures
the effect of a change in the interest rate on multiple years.

Regression results of Changes of Multiyear Real Housing prices
against Mortgage Rate

Years Combined Years Coefficient Intercept R^2 (% Explained) Significant at 95% Significant at 90%
1972–2003 2 years -0.268 0.023 0.155
Yes Yes
1972–2003 3 year -0.339 0.038 0.133
Yes Yes

Scatterplot of 3-year combined real housing increase against
change in the mortgage rate

Current Interest Rate Volatility

But how do we know where the interest rate will be in the future? We can
estimate the volatility of the mortgage rate by looking at the history
of the 30-year treasury
. I also looked at different terms 5-year and 10-year and my
volatility figures were very similar. When we extrapolate this data into
the mortgage rate, we are assuming that credit spreads do not change.
We also assume that the change in interest rate is normally distributed,
and we realize that the nominal interest rate cannot go below 0%. The
annual volatility is 4.22%. This means that there is roughly a 16%
probability that the annual mortgage rate will be above 9.22% (5% +
4.22%) one year from now.

Product Daily volatility Monthly Volatility Annual Volatility
30 year treasury Yield

The big picture

Using these results, we can ask ourselves what is the most that the
interest rate could change in a given year. Given the current rates at
about 5%, we would be wise to understand the risk to housing given
current scenarios (See below). We must remember when discussing these
numbers that they are the real housing less inflation. If there was a
significant increase in inflation, prices may just stagnate while in
real terms they lose 10% a year.

Secondly when dealing with statistics you always have upper and lower
bounds which bracket your expected mean. In this case the brackets are
quite large. The coefficient has an upper and lower bound 0.30 above and
below the expected mean. That means while on the lower end, with 95%
accuracy the mortgage rates could have negligible effect, on the higher
end, we could have a much higher coefficient than is currently
predicted. -0.63.

The intercept value is .038 which means that on average we should expect
a 3.8% increase in housing over a 3 year period of time, even if there
is no change to the mortgage rate. So when we conduct our scenario
analysis, we see that a simple increase in the mortgage rate from 5 to
7.5, we would expect to see a 13% decrease in housing prices over three
years. The worst case scenario at 95% would be a 45.8% drop. If
inflation really showed its ugly head and rates go to 11.75%, we would
expect a 30% drop in real housing prices with a worst case scenario of a
45% drop.

Scenario Analysis

Scenario Probability of event Expected Change Worst Case at 95% Timeframe
Increase 2.5% in one year
Over 2 ½ years
Increase 6.75% over 3 years
Over 5 ½ years


Given the risk of future inflation, housing is a poor bet at best and a
catastrophe at worst. While not wanting to sound alarm bells, the
potential on the downside is apparent. On the upside, the real housing
prices stay flat but the lower bounds are quite concerning.


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Fri, 07/09/2010 - 10:07 | 460355 Gully Foyle
Gully Foyle's picture

"Given the risk of future"_____

Fill in the blank. Alien invasion, Zombie plague, Penis shrinking malt liquor...

It's like listening to psychics.

I thought the other seers were going the deflation for a long period then inflation then hyperinflation.


Fri, 07/09/2010 - 10:20 | 460385 Whizbang
Whizbang's picture

It's a very interesting and well thought out piece, which reflects the somewhat complicated mathematics in predicting how interest rates and prices cycle. however...

1. I don't think inflation is anywhere near 5% and hasn't been for two-three years. With revolving debt plummeting and non-revolving stagnant, I don't see where it's going to come from.

2. All of your correlations are based on data leading up to 2006, when the whole shit show broke down



Fri, 07/09/2010 - 14:04 | 460867 edwardscpa
edwardscpa's picture

I'm hijacking the top thread.  Sorry.

There is a saying I like... it's better to be roughly right than precisely wrong.  The author's efforts, however detailed, seem to ignore the fact that anyone who is buying right now is probably trying to take advantage of 4.5% money, and is thus, "leveraged".  Focusing on real housing prices vs implied nominal rates is entirely irrelevant unless you are thinking of a cash buyer.  If the CPI doubles and rates skyrocket, but housing prices remain flat, then for argument's sake a cash buyer would show a 50% real loss in net worth (as related to housing), while a 100% financed buyer (again, for argument's sake let's say they still exist) would have no change in net worth, real or otherwise.  Further, any nominal increase in house prices will result in a real increase to the leveraged buyer's net worth.

The author's thesis is still interesting, and I would be very interested to see him revise the analysis to show nominal house prices vs interest rates and CPI, especially b/n 1970 and 1985.

Fri, 07/09/2010 - 10:19 | 460368 Mako
Mako's picture

I have no idea what that article is. 

Inflation is dead and has been dead for 2 years.  Rates are not going up, mortgage rates are not going up.  Slow death comes to mind.

Heck who wouldn't want to loan someone at 10% on a mortgage, unfortunately you ran out of lemmings.  You can't find the amount of lemmings at sub 5% let alone 10%.  

"If there was a significant increase in inflation"

Sorry there is no inflation now and the only way you are going to get inflation is if the US consumer request the commercial banks to manufacture additional credit.  Currently credit creation is NEGATIVE at a -$808B annualized rate based on Q1 numbers.

Fri, 07/09/2010 - 10:27 | 460399 packman
packman's picture

Inflation is dead and has been dead for 2 years.  Rates are not going up, mortgage rates are not going up.  Slow death comes to mind.

Yes because what happens for two years always continues to infinity, right?

How in the world is the U.S. government going to conceivably not default on its debt, if we don't introduce significant inflation soon?

Fri, 07/09/2010 - 10:45 | 460417 Mako
Mako's picture

"Yes because what happens for two years always continues to infinity, right?"

No, the collapse will continue until it's hits it's max, life is a series of cycles or waves.   Last down cycle lasted about 20-25 years or most of a generation.   This down cycle will be magnitudes larger and longer in duration.  Never said it would "infinity", two years nor two decades or two centuries is not "infinity".  You are still living in the good times, the collapse has only just begun. 

"How in the world is the U.S. government going to conceivably not default on its debt, if we don't introduce significant inflation soon?"

You actually answered your own question above, humans have no ability to inflate to infinity.

Fri, 07/09/2010 - 11:13 | 460516 packman
packman's picture

humans have no ability to inflate to infinity.

We beg to differ.


 - Robert Mugabe

 - Friedrich Ebert

 - Jorge Videla and successors

 - etc.


Fri, 07/09/2010 - 13:39 | 460820 gringo28
gringo28's picture



Hugo Chavez

Fri, 07/09/2010 - 10:31 | 460412 packman
packman's picture

Sorry there is no inflation now and the only way you are going to get inflation is if the US consumer request the commercial banks to manufacture additional credit.  Currently credit creation is NEGATIVE at a -$808B annualized rate based on Q1 numbers.

You're making a big leap of logic here - the same one made by the MSM - that consumer credit is down because the consumer doesn't want to borrow money.  IMO that's not the case - it's more a case because the banks are tightening credit and lending less; especially given the high unemployment.

If/when banks decide to loosen credit again (when they're finally able to offload all their s*** assets to the public via the government and FedRes), you'll see that consumer credit number jump right back up again.  Not because people all of the sudden want to borrow again, but because the banks are willing to lend.


Fri, 07/09/2010 - 10:43 | 460422 Mako
Mako's picture

"IMO that's not the case - it's more a case because the banks are tightening credit and lending less; especially given the high unemployment."

I can go get a mortgage tomorrow for about 5%.  You simply ran out of lemmings.   

I know 2 people that closed on houses in just the last month, no problems what so ever. 

The current standards are no worse than they were 30 years ago, matter of fact to me they are still quite easy.    The only way you are going to get inflation is to find the amount of lemmings that are wil$ling to take on the amount new credit as they were in 2007 which was at a nearly $4.7T rate.... which is only  $5.5T rate change from today's levels.   Good luck with all that. 

Fri, 07/09/2010 - 11:11 | 460488 MachoMan
MachoMan's picture

Bingo.  I bought in 08, fiance bought in 09 and refinanced in November...  no problems getting credit.  Lenders were scrambling all over themselves to give the loans.

The issue can also be seen in commercial real estate.  CRE is just like credit.  If a business wants to utilize credit (or commercial space) the return needs to be greater than the juice.  Simply put, businesses cannot borrow money and put it to use greater than the cost of capital (unless they have access to the discount window).  This is why commercial real estate is dead.  They ran out of lemmings.

Time for the "liquidation of nonperforming assets" Mako?

Fri, 07/09/2010 - 11:55 | 460613 Mako
Mako's picture

It's as simple as that, people want to make it complex because the gravity of the situation gets deadly.  

The system ran out of lemmings at the rate needed, the only thing that can happen after that is collapse.... yes, we are very early in the collapse phase.  There will be bounces within the larger down cycle as well.  

Fri, 07/09/2010 - 15:17 | 460998 mophead
mophead's picture

Lender's are scrambling to offer loans only because they now get to flip 95% of them over to Fanny and Freddie. They're after the loan fees. If they had to carry the loans, this wouldn't be happing.

Mon, 07/12/2010 - 13:33 | 464534 Geoff-UK
Geoff-UK's picture


Fri, 07/09/2010 - 11:20 | 460538 packman
packman's picture


Yes of course it's still easy relative to 30 years ago.  We've also had 180% inflation in that time (CPI 85 to now 218). 

I'm talking relative to 3 years ago, not 30 years ago, because your comment:

Sorry there is no inflation now and the only way you are going to get inflation is if the US consumer request the commercial banks to manufacture additional credit.  Currently credit creation is NEGATIVE at a -$808B annualized rate based on Q1 numbers.

refers to recent history.  Consumer credit has only been negative for 2 years now, not 30.  And only barely negative at that - $2.58B at its peak to now $2.42B.  Not exactly a huge drop at all.  In 2000 it was only $1.6B.


Fri, 07/09/2010 - 11:58 | 460571 Mako
Mako's picture

Total credit of the system is $52.1T(2010 Q1) down from $52.9T(2009 Q1).  Never once said consumer credit was negative for 30 years, don't know why people have to make up stuff.

"Not exactly a huge drop at all."

Consumer credit that you speak of is a drop in the bucket of the whole system, I have no idea what you are talking about... total credit market debt is $52.1T and you are talking about a few billion.  The fact of the matter is the system is in a death spiral, what spirals up will spiral down.

Now the $52.1T of the system, well, it needs to be serviced interest... whoops.  You can't pay with what doesn't exist or is disappearing at a negative rate.

"I'm talking relative to 3 years ago, not 30 years ago, because your comment:"

I have no idea what you are talking about, no they are not going to give an illegal alien a $500,000 mortgage like they were doing in CA. back in 2006, but they have no problem loaning anyone money.  I have no idea what you are talking, you in fact can go down and get a loan for a house, matter of fact they are giving away at ALL-TIME low rates.   The system is begging for people to take on more but the people are either unwilling or unable to take on more at the RATE NEEDED... the rate needed is exponential.

The bank would just love for me go on in and take out a million dollar mortgage.   No, if you have no documentation to prove your ability to service they are not going to give you a million, they tapped that system out in 2006/2007.  They only way they could extend the system in 2007 was to go to the cemetry and start digging up dead bodies and forcing them to sign up for a thirty year. 

Fri, 07/09/2010 - 13:31 | 460808 packman
packman's picture

You implied consumer credit with your statement:

Sorry there is no inflation now and the only way you are going to get inflation is if the US consumer request the commercial banks to manufacture additional credit.  Currently credit creation is NEGATIVE at a -$808B annualized rate based on Q1 numbers.

You are correct that total credit is of course much higher and is as you mention contracting.


 - It has a long way to go if it is to get down to pre-bubble levels.  Current is $49.6T, peak was $50.7, but pre-bubble (mid-1990's) was in the teens.  1995 total credit was $17 Trillion.

 - Given that the U.S. federal debt alone is $13.2T and rising like a rocket still - there's no way we get back even close to pre-bubble credit levels in nominal terms.  The only way we can get there in GDP terms is massive inflation.

Of course in the end we'll simply never get there at all.  We'll probably level off at a higher plateau of somewhere around 320% of GDP (currently we're at 340%) and then start back up again.  Then the final bubble - treasuries - will pop, and that'll be it for the dollar (and possibly the U.S. as a sovereign politicaly entity).


Fri, 07/09/2010 - 13:45 | 460836 packman
packman's picture

Here's a useful historical picture:



Fri, 07/09/2010 - 12:55 | 460743 robobbob
robobbob's picture

Maybe its no problem for personal loans, but loans on investment rental properties is dead, even with big cash deposits and heavy collateral.

The only people willing to put out loans on rental investments are hard money lenders at 15 - 20%

How much of the RE market is professional investors who are closed out of loans?

Fri, 07/09/2010 - 14:02 | 460860 Lux Fiat
Lux Fiat's picture

Lenders are like a hoard of flies buzzing around creditworthy potential borrowers.  Many who are creditworthy are that way because they didn't borrow, borrow, borrow in the past, and have no desire to do so in today's environment.

Fri, 07/09/2010 - 16:40 | 461194 Strider52
Strider52's picture

Lux, you just described me. I have a nice career, great job, plenty of dry powder, I am a TNSOG (True 'Nuff Stacker of Gold), and the last thing I want on this God's earth is a mortgage.

  I am, as one friend put it, "Off the Radar". I rent a nice house, grow lots of veggies, have stacks of supplies (more for the Calif earthquakes I fear), and I love camping.

  I could get a loan, just don't want one.

Fri, 07/09/2010 - 13:27 | 460796 pitz
pitz's picture

Deflation is created by excess lending, not inflation. 

You people have it all backwards.  An expansion in lending creates additional supply.  A contraction in lending destroys supply. 

Demand remains relatively constant, I mean, we all have to eat after all, eh?

People who merely look to lending statistics, and think there must be a correlation between credit growth, and inflation, quite frankly, are going to be in for a huge dissappointment.

Weimar Germany didn't have much, if any consumer lending.  Certainly nothing like we have today.  Yet they experienced a hyperinflation.  Same with Zimbawbwe; your average man on the street in Zimbawbwe has no credit whatsoever, and they still manage to hyperinflate over there.

Keep an eye on supply.  That's where you get hyperinflation from.  And from my vantage point, supply is collapsing, along with productivity and capital utilization. 

Fri, 07/09/2010 - 14:16 | 460897 packman
packman's picture

Weimar Germany didn't have much, if any consumer lending.  Certainly nothing like we have today.  Yet they experienced a hyperinflation.

Price inflation isn't necessarily experienced by the lenders though - it's experienced by the borrowers.  Weimar borrowed heavily, not in the form of consumer debt but in the form of war reparations debt, that they couldn't pay off, and thus had to inflate; in their case hyperly so.  Same with Zimbabwe, who had to hyperinflate to pay off IMF loans.

Much like the U.S.'s heavy borrowing that we may very well not be able to pay off.

In the end if things get bad enough - internal debt, be it consumer, mortgage, business, etc. gets lost in the overwhelming wave of sovereign debt.  Consumer debt etc. may end up being miniscule but it doesn't matter - what matters is the sovereign debt.


Fri, 07/09/2010 - 15:47 | 461080 LeBalance
LeBalance's picture

THE issue is SUPPLY.

The above article lumped massively different scenarios together under one umbrella and did not de-convolute the SUPPLY.


Thesis core malfunction.  Reset.

The reality of massive REO and other shadow inventory will continue to crush housing prices, even as other sectors experience inflation.  Expect continue price decreases in the housing sector until the Nx Trillions in malinvestments is unwound.  And considering the amount of off-book and off-off-book MBS and 1-8th order derivate circular file "mark-to-please don't make us shoot ourselves" nuclear waste is in the malinvestment column, that may be along time.  And to be real, it should all be written off today as a total loss if we want to gate jump to the endgame.

Just my $0.0000000002.

Fri, 07/09/2010 - 16:07 | 461120 ozziindaus
ozziindaus's picture

There are more contradictions in your post than I care to list but I"ll try.

Deflation is created by excess lending, not inflation.

Excess lending is the inflation. Where else does it come from?

An expansion in lending creates additional supply.  A contraction in lending destroys supply. 

Credit pulls future demand forward. When demand is not met, you have deflation through capital destruction. Remember the loan is still due at this stage. Default confirms the deflation.

Demand remains relatively constant, I mean, we all have to eat after all, eh?

For what?? Food?? see FDR policies.

People who merely look to lending statistics, and think there must be a correlation between credit growth, and inflation, quite frankly, are going to be in for a huge disappointment.

Your interpretation of the definition of inflation is disappointing. Credit growth = inflation.

Weimar Germany....Zimbabwe.... hyperinflation.

These were currancy crisis's with a destruction in confidence. Different dynamic to inflation/deflation.

Keep an eye on supply.  That's where you get hyperinflation from.  And from my vantage point, supply is collapsing, along with productivity and capital utilization. 

All demand driven and that is what's collapsing. We still have excess supply including food. That's why there are sooooo many great deals out there.

Fri, 07/09/2010 - 20:37 | 461558 pitz
pitz's picture

"Excess lending is the inflation. Where else does it come from?"

No, excess lending is the deflation.  Excess lending causes the creation of excess supply.  Pull back the excess supply of credit, and you get inflation because supply contracts.

For instance, let's say there's 1 sandwich counter in my community.  The owner runs a perfectly good business selling sandwiches for $10 a piece, enough to pay his employees, send his kids to school, and live a modest life.

Now, the banker comes into my community.  Finds someone to lend $100k to, in order to set up a second sandwich counter.  With the competition, sandwiches are no longer $10 a piece, but are rather, $7 a piece.  Another banker comes along, lends another $100k, and a third sandwich counter is set up, and the market price of sandwiches settles at $6 a piece.  Each participant barely makes any money, and the weakest manager burns through equity.

The credit has enabled additional supply.  When the credit starts to contract, ie: the bank finally calls the loan of the weakest sandwich counter, supply is removed.  Sandwiches start rising in price.  As sandwiches start rising in price, everyone senses "inflation!", and they demand higher interest rates.  The higher interest rates force another (debt-financed!) sandwich counter out of business, and prices rise even further.

See what's happening here? 

"Credit growth = inflation."

No, credit growth = consumer price deflation, but leveraged asset appreciation.

"All demand driven and that is what's collapsing"

Don't see any evidence that people aren't eating out there, or consuming other day-to-day consumables.  Prices on staples are rising like crazy around here.

Sat, 07/10/2010 - 12:17 | 462135 ozziindaus
ozziindaus's picture

Let's start by defining inflation since it is too commonly misinterpreted. Inflation is simply the increase in the money supply (Check M3). This is the cause. The effect may be what many misdiagnose as inflation (price increase or appreciation). 

So more money in the system through credit demand means the purchasing power of those dollars decreases and can, in some cases, lead to price appreciation. 

Remember that appreciation in price does not mean inflation but is instead one of the effects of inflation. 

Your example of the sandwich shop has more to do with supply vs demand. The shop owner can demand higher prices because he can due to lack of alternatives. This is a monopoly and the original owner should have known better than to think there was any secret in making sandwiches.

By extending credit to competition (inflation), it brings more supply into the market where demand remains unchanged. This drives prices down (depreciation) but it is not deflationary since the money that was credited into the system, with leverage, still remains in circulation. The more competition that enters into the market brings with it more inflation by definition (provided that it was financed). 

Now, as credit is contracted and not lent back out for other ventures (deflation), this raises the value of the remaining dollars in circulation. If demand remains unchanged for sandwiches, then the price may increase due to falling supply BUT the economy of this small town still takes a hit in other sectors due to less credit availability. The "weakest sandwich shop" owner has no money to spend into the economy. 

 As sandwiches start rising in price, everyone senses "inflation!", and they demand higher interest rates.

Again you are talking about price appreciation due to dropping supply. This is not inflation. Interest rates are determined by the market and are future projections of money supply. The banks don't set the rates at will. The public does through the bond markets in anticipation of credit expansion or contraction. Low rates mean deflation of the money supply ahead and vise versa for inflation. By definition, high interest rates with dropping demand is stagflation and requires more inputs than sandwich shops competing for business. 

Also credit expansion targeted towards sandwich shop investment with the intention of increasing supply leads to price depreciation of sandwiches but this is unsustainable if demand remains unchanged. Good example is Starbucks. 

In the food industry, you must adapt quickly to changes in the economic environment which many don't do well which is why it's a lagging indicator. The big players have all adjusted because they can afford to. Others that don't realize very soon that they are insolvent. 

Tue, 07/13/2010 - 02:57 | 465872 GoinFawr
GoinFawr's picture

"Inflation is simply the increase in the money supply (Check M3). "

M3 isn't being reported anymore. All figures for it are conjured up from cauldrons. Both M1 and M2 are still being reported and are increasing, even in this supposedly deflationary environment. Only one way to do that if credit is it follows that True Money Supply is expanding dramatically.

Oh, and credit isn't real money, but a means to 'creating' a hocus pocus version of it.

Just sayin'


Fri, 07/09/2010 - 13:37 | 460794 aurum
aurum's picture

How any of you can attempt to conclude anything from the last 30 years during the largest unsustainable creation of credit in the history of mankind is beyond me.. We lived and currently live in an anomaly that should not exist. We are headed out of the anomaly and into a new world.

Fri, 07/09/2010 - 10:17 | 460375 Calls and Putz
Calls and Putz's picture

We're entering "Youflation."

That's when the prices of things you own go down, and the prices of things you need go up.

Fri, 07/09/2010 - 10:49 | 460388 Mako
Mako's picture

You have entered a process where the things you call assets go down and the things you need just slowly stopped being produced.   The collapse is only at it's beginning stage. 

Groceries at the store are not going to go down drastically, the grocery stores will just close it's doors one day.  Production will continue to decline on a global level for many decades.  The process of getting a crop from the farm to a product that is sitting on a shelf at the store can't be reduced in priced in general, fixed long and short term costs.  They will just shutdown production and distribution for the lack of demand.

I know someone that works for a company that produces wood products for houses, medium sized company and they distribute their products through all the big retailers that you know of.   Well, in 2007 their peak and has collapsed from that point.

Now the nutbags out here think, well that means I can go in the store and get that product cheaper.... NO!  The company just shutdown unneeded plants to cut cost and not produce what isn't demanded.  The company nor it's competitors has any ability to cut cost to half.  

Production will continue to decline, distribution will decline, eventually all those stores will just start to disappear.  You might get some sales and close out sales but no most companies can't just cut prices, they will shutdown production.  Death spiral comes to mind.


Fri, 07/09/2010 - 11:06 | 460504 Rogerwilco
Rogerwilco's picture

"You have entered a process where the things you call assets go down and the things you need just slowly stopped being produced.   The collapse is only at it's beginning stage. "

Excellent analysis -- this is what most are missing in this deflation versus inflation debate. Scarcity from diminished supply will raise some prices even as the overall economy contracts.

Fri, 07/09/2010 - 12:00 | 460643 Mako
Mako's picture

Food will be the last to go.  Of course I don't see where food would drop half or anything either... it will just stop being produced because of the lack of demand.

Just read an article about a woman that claims she is 130 year old from Georgia old Sovient Union.   She said she had two kids die from sarvation in WWII.  People just don't get it. 

Fri, 07/09/2010 - 13:30 | 460804 Cathartes Aura
Cathartes Aura's picture

great analysis Mako.

with regards food production, I wonder how many people have noticed the volume decreasing in packaged products. . . such things as crackers, chips, cereals, all getting "new improved" packages, and smaller volumes of actual foods. . . it's been going on for at least 2 years (I know it's always a claw-back, but it's been very noticeable across the board lately). . .

bought some pre-made pesto last week for an outdoor gathering - while making the dressing, tasted - it was bitter, didn't taste like pesto - checked the ingredients - they'd padded out the more expensive basil with parsley - not an ingredient in basic pesto, but, hey, it was "green", lol. . . gotta watch the ingredients if not making things yourself, but that's always been the case. . .

Fri, 07/09/2010 - 17:10 | 461246 Augustus
Augustus's picture

I just bought a can of coffee.

It was once a standard 1 lb can.

Several years ago it went to 13 oz.

today's can was 11.5 oz.

Smaller cans of coffee cannot be cheaper to produce.  However, delivering a slightly smaller amount can reduce the sticker price / can and fool a poorly informed consumer into paying a few cents less for a product that has quite a few cents less product.  I belive the coffee example demonstrates that generally consumers don't know much about what they are buying for a whole range of consumer products.

Fri, 07/09/2010 - 17:43 | 461297 Canoe Driver
Canoe Driver's picture

and what's worse, canned coffee is absolute shit.

Fri, 07/09/2010 - 13:30 | 460806 pitz
pitz's picture

And how exactly does food suffer deflation or a reduction in demand?  People are going to stop eating?  Good one... 

Fri, 07/09/2010 - 14:28 | 460917 eatandtravel
eatandtravel's picture

I agree.  He lost lost me on that one.

Fri, 07/09/2010 - 15:20 | 461008 ozziindaus
ozziindaus's picture

The cost of production, transportation etc also drops. Remember that FDR burnt crops and slaughtered livestock to keep prices from falling.

Fri, 07/09/2010 - 20:22 | 461532 pitz
pitz's picture

I live in farming country, and almost without exception, most of the farmers around here are running little other than debt Ponzi schemes.  Mortgaging their land, for ever-increasing amounts, simply to afford inputs.

Rationing credit (ie: because of the credit collapse) simply causes those guys to be tipped over the edge, which is exactly what is happening right now.  Serial refinancings and chronic dependance on financing for farming is a catastrophe in the making, and supply, at least around here, is indeed collapsing, if not from flooding, from a severe reduction in fertilizer application.

Fri, 07/09/2010 - 20:25 | 461536 eatandtravel
eatandtravel's picture

During the WW1, food prices did increase because America was pretty much the only bread basket.  American farmers made the false assumption those prices would remain after the WW1. 

Sat, 07/10/2010 - 00:06 | 461791 jdrose1985
jdrose1985's picture

When people can no longer afford to buy food. Simple enough?

Fri, 07/09/2010 - 13:01 | 460727 jmc8888
jmc8888's picture

Yep I think you're spot on here.

Supply and demand aren't in a vacuum.   When you consider all the debt putting a floor on how low people can charge for their goods/services and still survive, we're literally staring over the cliff of the vast majority of our businesses, and thus all that are related to it, from simply being unable to produce anything at which they can sell above cost.  I saw this stuff coming even before I saw the Nasdaq crash coming.  Except now, it's getting to the point it matters, because everything else is so effed up.  The trend has been obvious that even a grade schooler could see it decades ago.

As for how the article's writer uses the data, it is purely a guess, and doesn't represent the entire view necessary to ultimately be accurate.  In a sense, it's luck.  Also looks like he kept his outliers in, at least in the graph.

But since he was on the right track initially it isn't completely useless.  But he didn't need the data chopped up in that way to figure it out, so he kind of went ass backwards and got lucky in his result.  Prices will drop when interest rates rise, when the glut of homes is put onto the market, etc.  It's one of many factors that could push prices down, whether it rears its head is another story.

Like my grandfather did in the first depression...and ended up with a 3 unit, 3 story flat building near Wrigley field very close to Lake Michigan for $4,600. 

In july 1929 a lawyer, from back east, who bought a house from my granfather (who built them) was talking to my grandfather about how two east coast banks had gone bankrupt and actually closed, and that this was going to cause a chain reaction. 

My grandfather, who was not just a simple builder, and even worked at the chicago board of trade, among many other jobs he had previously and would later come to have.   He then went downstate on friday night after work.  As the banker said it, if your father has money in the bank, get it out.  if you have any other houses as well, sell them at cost....and 'sell now or cry like a baby'.

He drove back to the town from chicago about 90 miles south to get his father's money out of the bank.  He got back after the bank had closed.   He called the president of bank at his house and got him to come down and reopen the bank. See the kind of service you USED to be able to get lol.

While there, the president pointed a finger in my grandfather's face and shook it and then pointed it at the police station nearby and said you'll get your money, but there's a police station down on the other end of the block for troublemakers like you.  He then pointed at the bank and the 1880 on it and said we've been around since 1880, don't you trust us?  Any of this sound familiar?

So he got his money out.  Waited for the crash.  Then they put the money to work, buying that three story flat, which obviously wasn't in the boondocks, and was only 2-2 1/2 years old....basically brand new.  It cost $20,000-22,500 to BUILD the flat, and he paid only $4,600.  So when people talk about real estate, how many talk about 75 percent off the COST TO BUILD the house/property. 

Not many, and we could easily see such things again, especially considering the numbers are far worse this time, then in the great depression.  But that is what is coming.  Now maybe not ALL transactions emulate this, but many will, and those that don't, won't be too much higher.

The prices just kept going down, and once the bs runs off this time, the true nature of THIS collapse will set in.  If rates do go up, it will absolutely be as big or bigger of an effect on housing than the 8k mortgate bribe that recently expired. 

People just don't understand HOW bad that was, and this time will be worse...considering everything is interrelated, JIT inventory abounds everything...because you can't have any money tied up in inventory, any more than 1 unit is too much, so when the crap hits the fan, we're oh so much more screwed than our ancestors.

So everyone should remember what came before us, and how bad things got, because we're headed not only there, but probably another thousand miles down the tracks.

Even though I never met my grandfather (dead), I'm sure we would have hit it off nicely.  Legitimate skeptics.


Good luck.

Fri, 07/09/2010 - 13:47 | 460837 spartan117
spartan117's picture

Great post.  Thanks for sharing.

Fri, 07/09/2010 - 14:07 | 460857 B9K9
B9K9's picture

I always enjoy Mako's posts because he's one of the very few who understand the really big picture. He in turn engenders comments/responses from others who actually "get it". I really liked your story - we shall see many more like that before this episode is over.

Of course, Bernanke & Geithner also clearly understand the really big picture as well, which is why they are perfectly willing to break every conceivable law on the books in a mad attempt towards reflating the market. I mean, the way they probably figure it is, if they aren't able to reflate the market (which they aren't), then the USA as a viable political entity isn't going to be around in order to prosecute their sorry asses.

It isn't so much the lack of lemmings, but the psychology behind lemming herding. You know, manias and all that. Once the party is over and everyone sheepishly slinks off hoping no one remembers their antics from the night before, private vows are made not to soon repeat that behavior.

Even worse, the boomer/X generations who are now learning these hard lessons (once again) are passing on warnings to the next. Kids of course are going to experience these events first hand during their childhood years. The out-of-work parent(s) forcing a move to a shittier neighborhood (or in with relatives, perhaps in a different state), the school shut downs (Hawaii was been on four-day week all last year), etc are all going to make, shall we say, an impression. That's why it took until 1955 to reach the previous highs of 1929 - almost 30 years!

The only point I differ with Mako is the outcome - he expects famine, etc, whereas I see just a slow grind. Go back & look at some of those Lange photos from the 30s. People weren't starving, marching, rioting, etc. They just accepted their reality and lived through it. That's what I fully expect to see happen again. Nothing glamorous, no Hollywood dramas, just existence.

Fri, 07/09/2010 - 14:26 | 460913 Dont Taze Me Bro
Dont Taze Me Bro's picture

Good post JMC.

But one big difference between your grandfather's era and the current environment is the difference in political regime in charge of the US. People like helicopter Ben and his cheerleaders weren't in charge back then.

Analysts who are forecasting deflation are assuming that policy makers are rational (or will stay rational), but every piece of evidence points to the contrary. From the insane bubblenomics that got us in the mess, to government's subsequent reaction to the crises, all indicates a continuation of all the insane policies plus more.

Do you think there will deflation if Bernanke were to expand the M1 money by $5-10 trillion?

Fri, 07/09/2010 - 14:18 | 460884 DosZap
DosZap's picture


Good splanation Lucy, left out one point, already happening.........

"Now the nutbags out here think, well that means I can go in the store and get that product cheaper.... NO!  The company just shutdown unneeded plants to cut cost and not produce what isn't demanded.  The company nor it's competitors has any ability to cut cost to half."  

The fact this has/is begining to happen, has had the opposite effect, prices are going UP, not the supply has dropped below demand.

Fri, 07/09/2010 - 17:58 | 461317 Augustus
Augustus's picture

Companies are much more aware of daily and weekly volumes, costs, and cash flows than just 10 years ago, let alone 80 years ago.  They will not produce product at marginal cost losses for very long.  As you write, they will shut down facilities and source from the lower cost locations.  They will also stop supplying the low profit outlets.

One factor that has not been mentioned is that there were no minimum wage laws in 1930.  Combine that with an understanding that all costs of product are really just accumulated wages being recovered for every process stage, plus some energy cost outlay, and it is pretty evident that it is more difficult for prices to decline today.  There will be little price inflation until there is wage inflation.

Another unmentioned factor is the percentage of the population engaged in on-the-farm agriculture.  I have not looked it up but would not be surprised if it was greater than 50% in 1930.  While they were not going to actually starve, they sure had hardship.  Now, consider that that agriculture population is now living in a city and on the welfare roll with guaranteed subsistance and no need to produce and it becomes an entirely different economy.

It has always been my belief that people will pay a reasonable part of their income for housing.  IF wages inflate then the payments for housing will also go up.  How that effects the actual house price is not certain as the higher outlay can simply become higher interest, not higher principal.  However, it seems almost certain to me that an investment today is a well located residential property with positive cash flow will be a winner over time.  Maybe not next year, but certainly over a decade.  Today's financing rates will not be seen again for a very long time, IMHO.  If I buy with substantial down and finance, say 70%, at 5%, I really don't have to worry much about the price.  The rental income increases with inflation and the major cost of holding is fixed for 30 yrs. 

Sat, 07/10/2010 - 16:01 | 462305 eatandtravel
eatandtravel's picture

During the Depression, Hoover and Roosevelt asked firms not to reduce wages although overall prices fell.  Real wages increased during the Depression according to Lee Ohanian.

1/3 of the GDP was related to farming back in the 1930s.


Tue, 07/13/2010 - 03:00 | 465873 GoinFawr
GoinFawr's picture

"We're entering "Youflation."

That's when the prices of things you own go down, and the prices of things you need go up."

+10 To that.

Fri, 07/09/2010 - 10:23 | 460394 43 Steelie
43 Steelie's picture

I remember some commenter posting on this site that the housing market will not bottom until it is an all-cash game. I completely agree with that assessment.

The author of this article makes the assumption that Fannie and Freddie will continue to exist in their current states for the near future, as will current lending conditions. 


Fri, 07/09/2010 - 12:36 | 460633 litoralkey
litoralkey's picture

The original thread makes some big assumptions:

1. The Case Shiller was a 9 city index when the index started.

2. What the author is confused about is the "median average duration of residence for American households with home mortgages", which is a statistic readily available with a few websearches.  The number has fluctuated surprisingly little in the last 30 years.  The National Association of Realtors (aka NAR , aka big fat liars) says 6 years.  The original article is finding something close to the mean length of the marginal market turnover in the time lag mentioned.

3. As 43 Steelie mentioned, the author makes the huge leap in faith and assumes the GSEs and United States mortgage market will exist ad infinitum in the current state.

The NAR has a significant body of work analysing what is in this post, though I think most of it is behind a paywall, or requires a visit to their library collection to find.  Probably available at some universities also, I know you can look at NAR archives at NYU Bobst library.


National Association of Realtors®

Profile of

Home Buyers

and Sellers



Page 40, figure 2-25 and 2-26 will provide some answers.

Page 80, figure 6-17 , Average length of residence of seller of home in US is 6 years in 2007-2008.



The typical home seller has owned

their home for six years. Very few sellers

(4 percent) owned their home for less

than one year, while one in ten had

owned their home for more than 20

years. Sellers of detached single-family

homes, which account for the largest

share of homes sold, owned their home

for a median of seven years. Sellers of

condos in buildings with five or more

units, along with sellers of cottages, had

the shortest tenure, with more than four

in ten owning their home for three years

or less.


Fri, 07/09/2010 - 12:22 | 460688 jdrose1985
jdrose1985's picture


I was passing out flyers door-2-door in a local neighborhood last night with my wife for our church.

120 homes, all roughly early 2000 models, roughly 20 were empty, only two of them had for sale signs out front. lawns still mowed but the giveaway was flower beds overgrown, some had paperwork in the front window but not many.

If there were a for sale sign in front of every one of those homes, I would think prices would drop 50% overnight.

Fri, 07/09/2010 - 13:33 | 460811 pitz
pitz's picture

43 Steelie, I've been pushing that view on many forums, because its been my observation that the bottom for any asset class only occurs when nobody, and I mean, literally nobody is willing to extend credit to potential buyers of such an asset class.


Fri, 07/09/2010 - 10:24 | 460396 Quinvarius
Quinvarius's picture

I think there is more going on than just inflation and bond rate comparisons.  Plus, a chart showing percentage price moves in a year does not give you an accurate picture over time of what the real home prices are doing.  Obviously, our housing market is backed up with supply, and the money available to the public is being strangled off by bank and corporate activities.  Those two factors are likely to work against housing prices no matter what happens.  But say we go into massive inflation and everyone is making $1000 an hour next year.  I am pretty sure you will find home buyers at 10x current prices, even if that is still a relatively depressed level.  Is that a great investment compared to foreign currency?  No.  But if you want to live somewhere and pay no rent, you could probably make it work out quite well over time.  Housing may not be a great financial investment in the form of REITs or whatever.  But 1 house on a personal level might be a good idea.  So maybe the real moral of the story, that we all just learned in 2008, is that housing as an investment does not scale well.

Fri, 07/09/2010 - 12:23 | 460689 litoralkey
litoralkey's picture

Right on all accounts.


Gold and PM investors like to post the graph of the loss of 95% of the value of a US dollar in a chart where 1900=100.

Such as this graph:

Case Shiller is inflation indexed, and starts at 1890=100.


The United States could see a bout of hyperinflation, and the Case Shiller index would factor in that hyperinflation using the imperfect CPI index, MASKING the real loss in wealth relative to a foreign currency, or to PMs, or to foreign currency denominated assets.

Top that off with the ongoing arguments about which inflation index to adjust the Case Shiller index, and you come out with an index that loses it's analytical value due to the shabby CPI index history in the last decade.



Fri, 07/09/2010 - 14:31 | 460923 Lux Fiat
Lux Fiat's picture

The United States could see a bout of hyperinflation, and the Case Shiller index would factor in that hyperinflation using the imperfect CPI index, MASKING the real loss in wealth relative to a foreign currency, or to PMs, or to foreign currency denominated assets.

Our gov't has an inflationary bent because most folks can't distinguish between real and nominal values.  But you touch on a more insidious factor - that current statistics understate true inflation.  This further reinforces the tilt towards inflationary policies by the gov't, because if people don't understand which inflation statistics to use when trying to look at real returns, they are that much eaiser to skin.

I've always taken CPI/inflation into account when looking at my real investment returns.  However, it wasn't until more recently that I started using better/alternate CPI data for my calculations.  It makes quite a difference between a very handsome looking return, and something that eeked out a much less dazzling real return. 

It's also interesting to look at investment returns factoring in the change of your home currency.  When you contrast a 25% portfolio gain against a 30% decline in the currency in which your portfolio is denominated, the "wealth effect" illusion dissipates pretty quickly.


Fri, 07/09/2010 - 10:24 | 460397 wang
wang's picture

anecdotal only but that first graph the author is using needs to have a full dataset attached to it (as in his numbers / assumptions look very suspicious) i.e. the timing of price peaks (and I know he's using real not nominal but a look at the data set and assumptions would be of value)


His statistics 101 lesson is well and good  but show me the raw data and where it came from. And no I'm not going to dive into Shillers and other sites to find the info

Fri, 07/09/2010 - 10:29 | 460406 white noise
white noise's picture

need to look at other variables. level of indebtedness now and 20-30 years ago, perhaps. if you are in debt - whatever rates you will not take a mortgage. if you think your job is at risk - same. however, if you have free money (ex: in stocks) that you think are at risk you may consider safe hard assets (housing). interplay between those two could be more important than presented historicals.

Fri, 07/09/2010 - 10:31 | 460414 traderjoe
traderjoe's picture

I think y'all are missing the point of the article - that the typical argument "today's low interest rates make it a good time to buy a home", is an incomplete statement (typically offered by your local real estate agent/banker/government official). 

IF interest rates/inflation go up, this makes payments higher for the NEXT buyer, thereby reducing the value of the home. Therefore, if you are buying a house now, just because interest rates are low, and plan on selling in the near future, you risk interest rates going up and the price of your house going down. 

I think it's a point all too often left out by the buy-housing-sales cabal. 

Fri, 07/09/2010 - 11:09 | 460510 LePetomane
LePetomane's picture

That's my read on it as well.  I'm sure there are more reasons that interest rate sensitivity isn't perfectly correlated.

However two reasons come to mind. 

1. Primary real estate that can't be sold can potentially be converted to rental units 

2. Rental demand increases as buying become unattractive.


In my mind, real estate is a good buy in a rising rate environment if you are serious about become a landlord.


Fri, 07/09/2010 - 14:31 | 460920 DosZap
DosZap's picture

Le Pet,

" if you are serious about become a landlord."

And you better  be damned serious, and live close.

The Nightmare from Hell...................renters.

And with this admin, trying to evict would be a ZERO SUM lost.

Fri, 07/09/2010 - 11:40 | 460578 OpenEyes
OpenEyes's picture

I agree with your interpretation.  Regardless of all the other economic factors that may drive home values up or down, there's no doubt that interest rates are the number one driver in either direction.  Interest rates are at fresh all-time lows and with virtually no room to move lower.  If interest rates can only go up from here, seems logical that home values can only go down from here.

Fri, 07/09/2010 - 18:02 | 461322 Augustus
Augustus's picture

Therefore, if you are buying a house now, just because interest rates are low, and plan on selling in the near future, . . . .

That would almost always be a poor decision, except maybe for the period 2000 - 2004.  If you expecct to hold through a longer cycle of maybe 10 yrs it should work out pretty well.

Fri, 07/09/2010 - 10:33 | 460415 economicmorphine
economicmorphine's picture

Great analysis and it is backed by common sense which makes it a home run.  Historically, housing is influenced by employment and interest rates.  Employment may get better, worse or stay the same.  I have no clue.  Interest rates have only one way to go and I know with certainty what way that is.  Based on today's reality (record low rates and no demand for housing without government cheese), the answer seems sort of obvious to me.  It's nice to have statistical justification though.

Fri, 07/09/2010 - 10:48 | 460449 anony
anony's picture

Interest rates have two directions, besides neutral, to go: up; and down into negative territory.

Fri, 07/09/2010 - 10:40 | 460419 Joe Sixpack
Joe Sixpack's picture

Obviously Taylor does not live in CA. He would have known this decades ago!

It's kind of like the car salesman says- "how much can you afford to spend per month".  This fixes what you can buy. interest rates go down, price goes up. interest goes up, price goes down.

Nice to see the analysis back it up.

Fri, 07/09/2010 - 10:40 | 460430 Deflation Dan
Deflation Dan's picture

I’ve been hearing the inflation/real estate price correlation since back in the seventies and eighties. It made no sense then, and makes even less sense now. I heard a very prescient question asked back in 1985, “If inflation dictated the price of real estate, wouldn’t the most expensive real estate in the world be located in downtown Buenos Aires instead of Tokyo?"

Fri, 07/09/2010 - 10:52 | 460463 Quinvarius
Quinvarius's picture

I am waiting until they start turning those Tokyo tube hotels into condos before I move into that neighborhood.  Looks like a nice town to raise a family in.

Fri, 07/09/2010 - 10:54 | 460468 Djirk
Djirk's picture

Shah, bankers...this is the problem with the Fed policy. Avg people don't make investments based on interest rates.....they use income and expected incomes (equity appreciation) for housing decisions. Both of which are less than rosy right now.

Fri, 07/09/2010 - 11:17 | 460472 scriabinop23
scriabinop23's picture

There are quite a few statistical errors here.

From 1977 to present, the annualized volatility of the 30 yr yield is around 15% (to 1 standard deviation).  So if we start at 4% yield today, a 3 standard deviation move will take us either 2.2% or 5.8%. (.3% chance of that happening on an annual basis...).  68% chance we get to 4.6% or 3.4% by the end of the year.  That's assuming a normal distribution is even the right distribution to choose ...  My statistics has quickly gotten rusty, but there is a test to determine this as well.  My point that still holds:  is that your #s concerning probability of where rates are within 1 yr are way off, regardless of chosen distribution.

That said, with an inflation-induced change in price level, lets say rents follow price level changes. The higher interest rate (to account for the change in expected return given higher inflation expectations) will result in a lower multiple.  Better to use finance tools rather than statistical regression to resolve this problem mathematically.  Too many errors come from misusing statistical data, as far as valuation...

So let's test this.  Scenario: Price level quickly doubles from 1 to 2.  Everything moves up linearly in CPI (fat chance). Interest rate goes from 5% to 10%.  (lets assume the market believes the change in price level is a one time event, which is why 10% is so low.)

Lets assume this means my house commands a rent of $4000/month (after price change) instead of $2000/month (before price change).  Lets say no expenses (prop tax, etc) just to keep the model extremely simple.  The expected return on the asset is 10% instead of 5%.  Lets price it like a perpetuity to keep it simpler.  Fundamental value starts at $480K with $2k/month price  (24K/.05). It ends at $480k (48K/.10).  The real money to be made is when inflation moderates and expected return on assets falls back to 5%.  Then suddenly (48K/.05) = $960K.  That's what 1983-1999 was about.  So yes, in real terms durable tangible assets are often hurt immediately by inflation.  But inflation rates are usually a volatile series, often tending to stabilize in the long run. This helps them catch up (in real terms).  Worst case, your new high wage has devalued the debt associated with home loan you took before the inflation occurred.

Fri, 07/09/2010 - 11:04 | 460498 JuicyTheAnimal
JuicyTheAnimal's picture

I dunno but I'm taking my coffee with my GF's goat milk this morning.  Tastes like coffee with goat milk.  It is.   

Fri, 07/09/2010 - 17:06 | 461240 Strider52
Strider52's picture

It's gotta be better than Yak milk. Ever tried Yak milk? Go to Tibet...

Fri, 07/09/2010 - 11:07 | 460506 augmister
augmister's picture

No inflation...DEFLATION...yep, buy that house right now because in three years, you will have a 20% haircut.  And how about the US GOVT sucker deal?   I will give you 8K to buy a house now that in five years will probably be worth 20-30% less!  Did you see all those blue smurfs line up and take that sucker deal?

The current sucker deal are the need to stop contributing immediately.  Why?  The write off you get now will be dwarfed by the larger amount of taxes you will have to pay on it when it comes out... Of course, that is considering the US GOVT doesn't do a SSI 2.0 and confiscate everybody savings.... just sayin'....

Fri, 07/09/2010 - 11:34 | 460563 Thoreau
Thoreau's picture

Property taxes are going up, and valuations have nowhere to go but down. Look for increased millage rates, and increasing inventories as banks are finally forced to account for all those limbo-homes/loans.

Fri, 07/09/2010 - 11:53 | 460615 ben313
ben313's picture

Very interesting post. Most of the criticism seems to be of the inflation assumption - conversely if you believe in deflation then you should be buying real estate...right?

Fri, 07/09/2010 - 12:01 | 460647 Thoreau
Thoreau's picture

And what happens to all those lenders holding existing mortgages in a high inflationary environment?

Fri, 07/09/2010 - 14:05 | 460868 pitz
pitz's picture

Couldn't happen to a more deserving group of people (oh wait, didn't the US Gov't and the Federal Reserve take many of those 'existing mortgages' onto their balance!).


Fri, 07/09/2010 - 12:42 | 460711 DosZap
DosZap's picture

"Yes, he was right that in a high inflationary environment, housing prices should rise with all other assets"

Yeah, in ordinary times ther value would follow somewhat, unless you had a 5yr supply sitting empty, and no one who will be willing / able to but either way.

But, like you said,high inflation, = higher interest rates, and there are few buyers at under 5%..................

Until Obama's programs can be repealed, rolled back, you would be an idiot to increase your debt load, with housing...........the sheer RISE of energy costs alone will eat you up,not to mention loss of write off of Taxes/Interest, and the NO WAY you can sell one, unless it meets the ..........Green Teams Energy Tests....

And God only, knows what the costs of those will be.

Fri, 07/09/2010 - 13:15 | 460769 s2man
s2man's picture

Owww.  You're all making my head hurt arguing about statistics and assumptions and charts and data.  And now ZH want's me to do negative arithmetic to post!  Owww.

I stepped away for a minute, though, and it is all clear now (I won't need the immodium).  You  are still talking about houses as if they were investments, like during the boom.  I just bought a home to live in, and a place to grow food and fuel.  This is my retreat, my bunker.  I don't care what it is worth when there is an economic/financial/world collapse;  I'll have a roof over my family's heads, and over my beans, bullets, bandages and bullion.

Financially, I look at this way - I just bought a repo'd, new, log house on three acres for 45k, appraised at 62k, with a 36k mortgage.  Come deflation or inflation, either way, I've picked up a freaking house for a fraction of my annual income!  Sounds like a good time to buy to me.

I figure I can pay it off in four or five years, so the interest rates are not relevant to me.  But if you think you will have a job for 30 years, then the low rates sound like a good deal, too.

And if I decide to move in the average 6 years, and the value of the house has dropped or sky-rocketed, so what?  The cost for the next home will have adjusted similarly.

Fri, 07/09/2010 - 14:01 | 460858 spartan117
spartan117's picture

You assume that you will continue to have that job for 5 or 6 years.  What if you lose your job?  What if deflation takes hold and your salary gets whacked 50-60%?  You seem to be doing fine since you indicate the price paid is only a fraction of your salary, but for most people, it's the other way around, where salaries are but fractions of their mortgage.  These are the people we need to worry about.  If standards of living continue to plummet, salaries will be the next thing to be cut.  And with fixed mortgages, that will only push housing values lower. 


I don't care about inflation or deflation.  I am more worried about job numbers and hourly wages at this point.  My guess is that hourly wages will continue to erode, as supply of labor grows due to weak hiring.  After all, labor is just another cost that moves with supply and demand.

Fri, 07/09/2010 - 14:12 | 460889 pitz
pitz's picture

I'm not worried about people having a 50-60% drop in their salaries.  What I'm worried about is the prices of day-to-day consumables such as food and energy doubling or tripling, such that, one effectively has a 50-60% drop in their wages in terms of purchasing power.

"Workers" that aren't working don't produce anything, thus, the production of the workers that remain declines.  And firms won't bring on more staff or invest in new production until they've more than recovered their losses over the past few decades in real wealth (relative to, for instance, those 30-year bond owners who bought in the late 1970s and have been sitting on their duffs collecting interest for all those years!).

This is why the market is going up, even though unemployment is going up.  Not difficult to understand how supply is being severely constrained, and will continue under its constraints.  No jobs recovery till Dow = 30,000 at least.

Fri, 07/09/2010 - 17:47 | 461302 s2man
s2man's picture

Yes, I am assuming I will keep the job for a few years.  I've made it through 8 years of persistant, sometimes quarterly, layoffs at the same company.  If I get laid off, or my salary is cut to match deflation, I'll have to stop the accelerated payments.  But then I'll only have the low-interest, $400 per month payment to make.  And I still won't care if the value drops, as long as I can make the payment.

I intentionally looked for something within my means to pay off, not just make the payments.  If someone was stupid enough to borrow 4 or 5 times their income, that is their problem.  And while I waited to close on it, the bank dropped their asking price from $50k to $40k.  Had I waited, I probably could have gotten it for 35 instead of 45k.  My point was, with prices and interest rates this low, it DOES seem like a good time to buy, to me.

As far as my doing fine, do you really think there is anyone trolling an investment site like this who does not make 45, or even 36k per year?  Yes, the house cost a fraction of my income, a large fraction.  But have you ever seen this before?  I haven't.  I bought a 40k house when I made 24.  I bought a 70k house when I made 45, before the housing boom.  Now they are asking 40 while I still make 60?  Hell yeah, I bought.  I'm putting every penny I can into physical assets, before the equities or FRN's are worthless.



Fri, 07/09/2010 - 14:19 | 460901 CoverYourBasis11
CoverYourBasis11's picture

We're entering "Youflation."

That's when the prices of things you own go down, and the prices of things you n



Fri, 07/09/2010 - 14:54 | 460959 ozziindaus
ozziindaus's picture

I tend to agree more with the comments than the author of the article.

House prices are more based on supply/demand and of course location. Inflation (CPI) in the articles context assumes wages will not follow. That has rarely happened in the past which is why inflation adjusted wages have remained stagnant for 30 years.

Also interest rates are market driven by public perception. 10 yr UST's, which drives the 30yr mortgage, is at low rates not because of inflation or deflation but because of uncertainty. Investors prefer the safety of US government bonds over yield and that's it. The 30yr mortgage is the consequence. Deflation is the result of low credit demand and not implicitly connected to interest rates.

Since housing is the single largest purchace an individual may make, then it goes to show that housing activity is a major driver of inflation. Today, the lack of activity is the major cause of deflation due to less credit being extended out to the public (no demand). Again, deflation in house prices are the result of this inactivity.

Put simply, interest rates, house prices and inflation have no direct correlation. It still goes back to the old supply vs demand and location.

Fri, 07/09/2010 - 16:40 | 461196 DosZap
DosZap's picture

I know a lot of you (like me) care not for Nadler..........

But, this article by Roger Weigand, is well worth the read..........98% I agree with................and I think it's worth most of our time to read it.



Fri, 07/09/2010 - 16:50 | 461207 mophead
mophead's picture

Everyone is missing the big picture. First of all, interest rates do matter and there is certainly a lag factor (this article was long overdue). But you need to double check using inflation adjusted numbers, otherwise, it might appear that interest rates are high, but actually low relative to inflation (high nominal, low real). Secondly, and more to the point, what determines house values are household incomes. So, if you believe values will go up, *in real terms*, then it means you believe total household incomes will go up, if you believe otherwise, then they'll go down. As for nominal interest rates and values? Who the F knows.

Oh crap, I forgot all these other variables: government incentives, property taxes, demographics. So obviously, prices will go up for these reasons:

1. Government to double down on incentives and expand MBS purchases!

2. States, led by democrats go on property tax reduction frenzy!

3. Demographics: boomers (another word for, drug addict, 'dead-head' losers who destroyed this country while mistreating their Gen X children, but will face the wrath of Obama's health care rationing euthanasia system as pay back) discover crystal meth and go on house buying spree!

Fri, 07/09/2010 - 20:52 | 461581 Milestones
Milestones's picture

Two years after the bottom comes out of this  economy none of your stats, bank rates etc will mean shit. What will count is your street smarts and how well you can play poker and understand how to make deals-and I don't mean just $$ deals.

There are an awful lot of the other wise smart people on this site are going to get their nose opened about what is really important, and why. I sound arrogant I know, but I have a college education and a knifed 3 times by the time I was 19 city street one. For the first few years I know which one will be in play.

Learn about how to make your way with that culture--you will be in it. It will not be about CDS's etc.  Milestones

Sun, 07/11/2010 - 01:03 | 462783 j0sh1130
j0sh1130's picture

there is also this simple way of looking at things - for every 1% increase in interest rates, you can afford to buy 8% less house (assuming a fixed monthly payment you can afford).  so if rates go up and prices go up, youre fucked.  this is why its a good time to buy. but this is also why no one explains to you that you are going to be locked into the home you buy cause rates wont stay low forever. 

Mon, 08/23/2010 - 15:43 | 538364 EconomyPolitics
EconomyPolitics's picture

Except you lose your 20% down payment. 

Thu, 08/19/2010 - 11:04 | 530365 herry
herry's picture

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