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Guest Post: How Housing Affordability Can Falter Even as House Prices Decline
Submitted by Charles Hugh Smith from Of Two Minds
How Housing Affordability Can Falter Even as House Prices Decline
The assumption that lower home prices improves the affordability of houses ignores two critical inputs: interest rates and income.
That the U.S. housing market is still in a post-bubble slump is no secret, as revealed by this chart courtesy of streettalklive.com: note that despite unprecedented intervention, including the complete socialization of the U.S. mortgage market (99% of all mortgages are guaranteed by the Federal government) and the socialization of subprime market for poor credit risks (3% down and easy credit from FHA), this chart punctures the happy-talk illusions of a rebound in housing.
Credit-asset class bubbles cannot be reinflated because they follow an S-curve. No matter how much taxpayer money the Federal government throws into the housing market, it will not reinflate. The financialization (credit/leverage bubble) of housing follows an S-curve as a system, and tweaking the parameters of the inputs (lowering interest rates, buying up toxic mortgages, etc.) doesn't change the curve.
Hubris-soaked central Planners are incapable of understanding that their numerous policy interventions have essentially zero impact on the curve. But if you can't believe systems don't respond to frantic policy measures, then consider these factors:
1. Tens of millions of households are too poor to buy a home (the FDIC calculated 40% of the U.S. households have insufficient income and credit to buy a home) without massive subsidies, and with no skin in the game their purchase is basically a lease with an option to sell later for a private gain at the expense of the government.
if it doesn't work out then it's last one on, first one off: they default with little loss and possibly much to gain, i.e. two years living rent-free in a not-yet foreclosed house.
2. Tens of millions of other households are drowning in underwater mortgages they can afford to pay (barely) but that have crippled their net worth and borrowing power. They are out of the housing market except as potential defaulters.
3. Millions of other credit-worthy buyers have woken up to the fact that buying a house is a form of consumption and a risky "forced savings" investment, as property taxes spiral ever higher and prices continue sagging in many markets. The risk is high and the potential gain is uncertain.
Those snapping up housing for cash are either buying to rent the homes or to speculate that a resurgent housing market will arise and they can "flip" for big profits. This segment simply isn't large enough to soak up all the millions of homes languishing in the "shadow inventory" of homes being held off the market in the vain hope prices will bubble higher.
The general idea of lower home prices is that once prices fall to some magic threshold, buyers will jump in and liquidate the inventory. That notion makes two enormous assumptions:
Interest rates will stay near-zero when inflation is factored in
Household income will stop declining.
In other words, there are three inputs to housing affordability, and price is only one of them. Interest rates and disposable income are equally important. Note that income in all quintiles (the entire spectrum of income--high, middle and low) has been declining since the housing bubble topped in 2007:
Official inflation has been running at around 3% a year, and many other measures suggest that number grossly understates reality by gaming the percentages of various inputs.
But taking the official 3% as a reasonable approximation, then buyers of 4% 30-year mortgages are earning a wafer-thin 1% in real return (4% - 3% = 1%) and they are taking a stupendous risk that inflation will remain well under 4% for the next three decades. Any surge in inflation and rates would destroy much of the value of their investment.
Let's take two examples. Let's say a house that sold for $400,000 at the top of the bubble is now selling for $250,000, $50,000 down (20%) with a $200,000 mortgage at 4%. let's say the household earns $50,000, so the mortgage is exactly four times gross income. The interest on the mortgage is $8,000 annually (principal, property taxes, insurance etc. are added to make up the total mortgage payment).
Now let's say the house declines in price to $225,000, so the down payment drops to $45,000 and the mortgage is $180,000. But let's say investors are now demanding 3% above nominal inflation and mortgage rates are now at the historically moderate level of 6%. Meanwhile, the household income has slipped to $45,000 annually as bonuses and hours are trimmed and workers transition to lower paid positions.
The ratio of income to mortgage is still 4-to-1, but the annual interest payment is now $10,800, $2,800 higher--a 35% increase. By any measure, the house is less affordable despite declining $25,000 in price.
This is how affordability can decline even as home prices continue to slide.
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Housing Market's been TVIX'ed.
Owners have been TVIX'ed.
Buyers have been TVIX'ed
The man in the basement getting a taste for it (sorry different song)
But taking the official 3% as a reasonable approximation, then buyers of 4% 30-year mortgages are earning a wafer-thin 1% in real return (4% - 3% = 1%) and they are taking a stupendous risk that inflation will remain well under 4% for the next three decades. Any surge in inflation and rates would destroy much of the value of their investment.
You flip that over to the buyer;s POV.... if you can buy well below replacement cost at artificially low rates in markets that have already been crushed... AND you can afford the payment, you will likely do well over a 30-year hold. Not arguing, just saying....
How Housing Affordability Can Falter Even as House Prices Decline? Thank you for that question Tyler.
I have a very simple answer. " Deficit Spending"
Definitely one variable that we can all agree will continue as far as the eye can see.
Retirees face a perilous financial decade ahead – Over 30 percent of workers have less than $1,000 saved for retirement. Defined-benefit plans down to 20 percent from over 60 percent in 1983.
http://www.mybudget360.com/retirees-face-perilous-financial-decade-one-t...
I read read everything you people write. I'll work harder!
In the mean time, townships with underfunded bloated public pensions and pay just keep raising property taxes and fees. Averaged the rate is 5.25%/year over 24 years. Over the last 2 years property taxes increased 30% to make up for public budget shortfalls.
250k@4% $1163/mo, $418,739.01 payments, $143,739.01 interest
225k@6% $1266/mo, $456,008.74 payments, $208,508.74 interest
Or....
200k@4% $930.53/mo, $334,991.21 payments, $114.991.21 interest
Praised be the Bernank, bringer of cheap real estate, puffer up of 401ks, and general printer of last resort. Aben.
Everything! 50 Basis points make you whole! Mad Scientist.
The US seems to be in similar position to Japan. The prob is after the recession Obama miss alloacted Govt spending (ie how many fast trains did he build / where is the new energy grid he discussed), hows the energy infastructure he proposed working. ie he waisted the stimulas on non income earning expenditure and not income earning assets and now that borrowing needs to be paid back with interest. So this is going to have a long term slowing effect on the economy. With Europe in same situation and entering recession, China entering slow down (as export demand slowing property sector over build ) Japan still in trouble with power issues which may slow economy, and all experiancing population demographic changes (ie aging population decreased demand).. there is a change we may still see golbal deflation, as demand slows.
So hoping for usual upswing because prices have fallen maybe be a mistake. Japan increase rates once after initial ZIRP policy and economy contracted.. Ron Paul's idea although radical is the only way back, ie the budget must be balanced the deficit shrunk on stable path. The Govt can improve tax revenue buy reducing regulation (ie energy sector / farming ect) to increase output without Govt spending money.. Free up the economy and the wipe out the the banks that should have gone under, and give their assets to functioning mid sized banks that are focused on regional growth.
You miss one very important point.
Debt and demographics are common to the US and Europe,but the public
infrastruture is excellent in Europe.It is the private infrastruture that it is
getting aged in Europr.However they still have both.We have neither in the US.
Pubic inrastructure is on its last legs,and much of the private has been off shored
Let's see, before the housing bubble, bought a foreclosure, a "moneypit, and/or "Pacific Heights", watch the movies. eat some popcorn, learn!
No one understands you ( non_anon)? Am I correct?
Burn This http://tickerforum.org/akcs-www?post=135432
Maybe it's high time you and I get in the chat room?
You posted a link to Denninger's site. What's wrong, friend?
@ Yen:
I'm way more passionate about this Jay-Z music video than your Denninger link.
So why don't we chat soon? It's just gonna be a couple of hot guys engaging in an internet chat. LOL
http://www.youtube.com/watch?v=0UjsXo9l6I8
I don't care about what anyone says about you, Yen. Even though you posted a link to Karl D's site, you're actually really cool.
Best party ever, whoo!
So how about we hook up in the chat room? Sounds good, no?
http://www.youtube.com/watch?v=KlyXNRrsk4A&ob=av2e
@ Yen,
I always suspected you to be a whiny bitch. Yet I've been more focused on people paid to comment here. You most def are not one of them.
But then again, all doubt has been removed to you as to how smart you are after you linked to Denninger's site.
I'm gonna put up another Kate Perry video just for the lulz.
Perhaps you and slewie can have a few more inside conversations. That's sure to take humanity to a better place.
L-O-L
http://www.youtube.com/watch?v=18oYGsmUprM
What are the horizontal and vertical axes for the S-curve? The author evidently does not have a background in maths or science. Yes I know, I am a nitpicker.
The middle class will be living like the Chinese and Indians before its over. Globalization bitchez.
In addition, the gov't wants to make housing affordable again by writing down everyone's principal. The Madness of King Barack.
http://confoundedinterest.wordpress.com/2012/03/25/fannie-and-freddie-sl...
Housing bubble has been reinflated at a lower price point.
Frankly, the best reason to NOT buy real-estate is the completely corrupt system that controls everything.
All levels of government, but especially the federal government now regularly changes rules and contracts, and forces those involved to apply the new rules retro-actively. Since the federal government is indeed involved in 99% of real estate loans today, 99% of buyers will eventually have their deals get worse, worser and worsest as the years pass.
Furthermore, property taxes are already rising like crazy in many parts of the country, and the rest of the country will soon follow. Their excuse is the same excuse that all levels of government are giving today - we cannot reduce our payroll, we cannot reduce the bloated salaries we pay, we can only become a more overwhelming and malignant cancer as time passes.
Finally, the large corporations that control government will also get an increasingly large piece of every homeowner hide as time passes, for they write the laws and regulations the government passes and enforces. So expect homeowner insurance rates to increase, expect mortgage guarantee insurance to increase, expect endless forced "services" to become required and ever more expensive as time passes.
The best reason to NOT buy real-estate is... your real-estate makes you the ultimate sitting duck. You become immobile prey that cannot move out of sight, out of mind, out of reach of the predators-that-be, predator-class, and parasite-class that the predators bribe for votes.
The only way to stop being immobile prey for the slime of this world... is to move to the [extreme] boonies in a place where people are poor but civil. The best places of all are where a large portion of the population lives their entire lives without every having or needing one penny (real or fiat). Yes, this is very sad, extremely sad, revolting and disgusting. But this is the price for accepting the existence of fictional "authority" for so many generations, and letting predators take over those fictional "institutions" that control everything and everyone [in populated areas].