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[finprof]

I am not sure if for most people it makes sense to look at inflation-adjusted home prices. Suppose I buy a home for 500K, borrowing money at a fixed interest rate. If inflation is 10% and home prices appreciate 10% I own a house that is worth 550K and my debt is still only 500K. Seems like a good deal to me. Borrowing money at a fixed rate and buying a house could in principle be a good inflation hedge.

[admin]

[john p]

In my line of work we have this thing called "Value Engineering". Value is defined by Benefit and Cost (two components).

Financially speaking, house values seem to have three components: Price of the house, Cost of Capital, and Market Value.

Looking through each prism:

Price of the House - prices are near historical highs relative to incomes.

Cost of Capital - cost of capital are near historical lows relative to history. The danger here is that lending standards are going up.

Market Value - in most communities, prices are tending downward, so even if the first two balance favorably, why jump in if it is trending downward?

In a combination of above, you need to assess the different trends and the trend of your financial position. If a down payment isn't a big issue for you, the increase to lending standards might not be a big deal. If you only have 5% and 10% becomes the norm, than you just lost your emergency fund or money needed to renovate.

I predicted earlier that prices would hit bottom this Spring because I thought mortgage rates would drop. I thought this because although the US Dollar was losing value, it would make sense for a Bank to get people signed up for a $500k mortgage before the house price dropped to $400k. My assumption was that as long as 9 out of 10 could carry their mortgages at $500k because we didn't have job losses and inflation would bouey salaries with cost of living adjustments, that if 1 out of 10 was upside down and was foreclosed on, the Banks would make enough on the others that could sustain the premiums. From my interview with some bankers, it seems that the few that do go under cost banks an awful lot more than a 1 to 10 ratio like I assumed. I haven't been able to get my data to support what the real ratio is where you profit good to bad loans...

When you look at the value of a median house in Massachusetts versus the value of the US Dollar, you'll see that the Dollar has not performed as well as the median house value. The US Dollar hasn't even kept up with the Dow Jones Industrial Average. What does the US Dollar represent? Is it a value in the stock of the United States, perhaps to some degree right? Because it is the medium of exchange that our debt like our mortgages is based, maybe the discussion at times ought to center around the value of the Dollar and not the house?

[finprof]

[quote="admin"]

[john p]

The other two theories I have are:

Raising interest rates does two things:

First, it devalues the Debt we owe by dilluting it with more money. People will get increased cost of livings in their salary adjustments to reflect inflation pressures so a few years of a 4 to 5 percent cost of living adjustments and you're in a better position to jump over your monthly hurdle. Great way to get out of the Iraq War Debt huh?

Second, it freezes sales activities. If most people that would consider buying have lower cost of capital, they might be interested in the lower prices at first, but when they factor in what a jump of a point plus would do to their mortgage rate, it might not be worth it. It was like the FED put the clutch in to disengage sales activity during a downward cycle. By increasing the rates it was like slowing down by down shifting, each gear was like the higher rate. Further, the majority of the available inventory was at the entry level price points (forclosed or people caught in ARMS). This was wny the majority of sales activity has been at this entry level, which is why the weight of activity is pulling the median lower. When we design buildings we have to worry about gravity and uplift like a kite sailing away. The FED needed to ground the ponzi uplift aspect and fight inflation while creating affordablity at the entry level. Maybe history will prove that raising the rates was that medicine. If he could get individuals and the Goverment to subscribe to Pay-Go that would be the trifecta. Think about if a war plane was being shot at by guns on the ground, they might decide to increase altitude and get out of range. The FED might have tried this strategy because if properties remained relatively affordable and you had this downward mentality, it migh have snowballed downward in a frenzy. Maybe the frenzy was adverted or put off for some time because he pulled the plug?

As far as the US Dollar being the predominant medium of international exchange and English being the predominant international language, I wonder how we get people to pay for the War and for us to be the watchdog without having them to pay for the War. I wouldn't be surprised if Countries suspect that we are manipulating the currency for self serving purposes. Are we economically treading in moccassins or stomping like a workboot? What is our footprint? Until we have a little more prescriptive Capital Structure Economic Theory on a Global and National Level, we'll just have to listen and scratch our heads with the FED Speak. If I were a Senator, I would ask again and again and again, to simplify and distill the gobily-ook down to digestable and understandable terms.

I think for the first time, we saw some serious dialogue between international central banks. If the international elite start to pull the reigns in we might end up with a New World Order. Maybe we need a New World Order to prevent currency manipulation by a Nation. Honestly, I'd prefer to not have to rely on people but perscription. We have an International Building Code now, why can't we openly and in sunlight try to prescribe parameters that create a balanced, flexible and sound capital structure? The basis of even that is our value structure which is integrity, honesty, honor copyrights etc. If we don't uphold contract law, we'll never get to moral hazard level stuff. My feeling is that just like we rise out of reach of guns on the ground, we ought to pull back from doing business and transfer wealth to the wackos.

[admin]

[Guest]

[admin]

[finprof]

[admin]

[john p]

One refinement to my perception of the whole inflation adjusted price line trend would be an understanding the timliness of data that weaves into it. For instance, we know that the recorded sales reflect deals that may have happened a month or two prior and it reflects the prevailing interest rate at the time. I am not sure when the inflation data is put together and what time period it reflects. This is really fine tuning. It is nice to have aggregate readings and to track it in other ways as well.

Shifting subjects, but kind of related is as we discuss inflation, I think about what percentage real estate represents in the overall value of collective net worth in our economy and how has that changed over time. For a median person profile what percentage of their personal net worth is their house equity? Then, what percentage of their gross monthly income is dedicated to servicing the mortgage.

I wonder how that percentage has changed over time. When the M3 skyrocketed (and is now dipping, than's for the reference to Mish's, Admin) that meant that more wealth was being put into liquid forms and liquidity was manufactured. So what I'm saying is how does wealth migrate from one form to another? If you look at wealth as a pie chart what is interesting now is that US Dollars aren't just a medium of exchange, it is almost like an equity. So, if the value of the US Dollar is moving around quite a bit, and the price of homes are moving, why are incomes stagnant? My view is to look at that pie chart and figure out which segment of the pie is growing and which part is shrinking. It is clear that the segment of the pie that was for real estate got bigger in the past decade, but maybe it was because value was spilling into it from other pie segments. House values might drop and prices may significantly drop because the numerical amount of dollars might not drop but the value of the dollar drops. Basically, the measure, say if we measure height by feet and we say this guy is 6 feet tall. Then, we change the definition of a "foot" to thirteen inches; that guy is now shorter using the new unit of measure. The US Dollar is the unit of measure and that is why it is hard to determine value.

[kenfeyl]

Reporting inflation-adjusting house prices can be misleading only because it's not typically done for other financial instruments. Ever seen an inflation-adjusted S&P 500 graph over the past 50 years? Probably not. If you have, it's pretty depressing. The real return is about 2.4%, enough to triple your money in 50 years. Big whoop. But people are used to hearing all sorts of happy stories about 8% return on stocks. And bonds typically return close to inflation over the long term.

[admin]

[kenfeyl]

Just for kicks, I went ahead and produced a plot of the real ROI on the S&P and the Dow since Sep. 1958, 50 years ago, using Yahoo data for the index prices and the CPI-NU for the adjustments. It's quite depressing indeed. You need to wait until 1986 or so just to go above breaking even. At the end of all this chicanery, you've just about tripled your money (a bit more with the S&P 500 and a bit less with the Dow). And this is assuming no fees! Check out the image below and knock yourself out. Most of stocks' oft-cited "consistent growth" is just due to the consistency of inflation.

[/img]

A few other observations:
- On what do we base our deep-seated assumption that stocks will rise over time. We really have only two data points here: the consistent drop from 1960 to 1983 and the consistent rise since then. Is that something we want to hang our hat on?
- Inflation-adjusted, stocks seem like a heck of a lot of risk for what amounts to a pathetic annualized real return (3^(1/50) =~ 2.2% a year). Bonds would probably be just a tad above inflation, but a lot smoother.[/list][/list]

[admin]