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http://www.marginalrevolution.com/marginalrevolution/2010/08/dont-obsess-over-interest-rates.html

Don't obsess over interest rates

After doing an extensive quantitative study, Glaeser, Gottlieb, and Gyourko report (ungated here):

Interest rates do influence house prices, but they cannot provide anything close to a complete explanation of the great housing market gyrations between 1996 and 2010. Over the long 1996-2006 boom, they cannot account for more than one-fifth of the rise in house prices. Their biggest predictive influence is during the 2000-2005 period, when long rates fell by almost 200 basis points. That can account for about 45 of the run-up in home values nationally during that half-decade span.

Posted by Tyler Cowen on August 3, 2010 at 03:23 AM

[CL]

Interesting - I always thought the reason for the run-ups/bubble is less due to the credit price (interest rate) than credit availability (banks lend to the un-lendables given rosy house price assumptions). But I always find it tough to find a clean relationship between mortgage rate and price.

[admin]

Being able to account for 45% of the run-up in prices during the bubble seems pretty substantial to me.

- admin

[john p]

Interest Rates are emblematical of future projections of earnings, growth, and therefore future value of the Dollar.

Salary Growth

During that period people saw there future as being bright and rosey and many saw their salaries grow double in ten years (especially those who were younger). Many in my profession between the ages of 23 to 33 saw their salaries grow 4 times. In the financial industry some saw 6 to 8 times. Because the sky was the limit, people didn't care about house price because their salary was going up and up and up as was many around them when they went to crowded open houses.

The loose credit was a result of the notion that your loan to value didn't matter as much because after a few years, the market would go up another ten to fifteen percent so even with a 5% down payment, you wouldn't have to worry about Loan to Value because of price appreciation. I mean this was the common thinking back then, I had people tell me this.

Money Supply

Imagine boats sitting on the water. The value of many things were buoyed by the money supply (as much of it that was made liquid).

http://bigpicture.typepad.com/comments/2007/12/no-inflation-no.html

Look at 2004/2005, look what happened to the M1 and M3

http://bigpicture.typepad.com/photos/uncategorized/2007/12/21/sgsm3.gif

[JCK]

[balor123]

I also did this analysis in a post a few months ago, looking at Boston only. I don't think it was quite 45% by my calculation but certainly big. Appetite for risk has risen enormously over the past 30 decades and, despite deleveraging, household debt still remains at record levels. As the Japanese have learned, it's a long painful ride down. At least the GSE cramdown requirement turned out to just be a rumor. Though I suppose something nasty may still be in the works.

[CL]

GSE will need to go - it just does not work. What I do think, however, is that the government would not let GSE go without someone picking the responsibility of securitizing mortgages (some private enterprises). So the end result probably be a removal of government guarantee of mortgage which will raise rate, but not reducing availability.

[balor123]

I think I and others would love to see GSEs go along with government backed mortgages. I would rather see them use the money to reduce the cost of buying instead of increasing the buying power. The government could, for example, use that money to buy land and build cheap houses on them, that are resold for a loss with restrictions on what kinds of profits can be made on them like subsidized housing in the Greater Boston Area. The only real problem with that is that it might crowd out other investment, making housing more expensive for others so care needs to be taken to ensure that only a minimal amount is built. There also needs to be recognition that unless cities are stripped of zoning powers there will likely not be a universal housing solution, something they thought infinite mortgages would solve.

[john p]

This is the best line I've heard in a very long time:

baylor said:

[mpr]

[admin]

[mpr]

[admin]

[john p]

I believe that there were unintended consequences to policies that intended industries to behave as if they operated in an ideal world versus the world that actually existed.

Let's just say that there were neighborhoods that were plummetting in value, and lets say that racism was the cause. Is it the Bank's responsiblity to ignore their own risk even if it is based on something immoral? The banks used market trends, income history, down payment as given in their risk assessments. The Lenders like Ameriquest were predators because they were putting some minorities into arrangments when they qualified for a much better deal. Now, what if we never had the Community Reinvestment Act, which tried to arrest a migration pattern which was leaving urban wastelands? It's the same kind of question as to what would Iraq be like if we still had Saddam Hussein.

I think the real problems came in the second wave, i.e. the Ammendment Period of the Community Reinvestment Act in the mid 90's. This was like the period where you had some people fighting for poor people on one side and the other had these Halliburton types that wanted to profit and take advantage. The Amendments to the CRA allowed for the securitization of subprime loans. This basically floated the risk downstream. The bleeding hearts got their poor people a chance to own a home (for the time being) and the Banks didn't have to absorb the risk, they could pass it off. The Halliburton types in banking were pushing for higher debt limits, new types of products they could sell i.e. derivatives and the like, and they got their Commodities Futures Modernization Act, which now could amplify this newly created subprime risk through increased leverage limits and create a massive battering ram of a hedge pendulum in Credit Default Swaps that grew bigger and hung above us like a Sword of Damocles. (which fell in the Fall of 2008). I think that it was during this wave, that deals were made between the bleeding hearts and the Haliburton types and neither group cared about the structural integrity of how this was all going to play out. For the first time, the divide wasn't Republican Democrat, it was Responsible versus Irresponsible. The Irresponsible Democrats and Irresponsible Republicans made their deals and prevailed. The Irresponsible Democrats wanted to limit the underwriting standards, increase the risk to the Banks, and the Irresponsible Republicans wanted the Banks to have the ability to avoid the newly created risk and to also make them rich by still letting them get their transaction fees.

The third wave of problems came with the corruption of both the government, the administrators of the policy, and the banks. The third wave was the Bernie Madoff type wave where you had one guy cheating like crazy and the regulatory industry turning a blind eye. Because the deal was now that risk was going to a toxic waste dump in investments that people didn't really understand or account for, it became the Wild West. Banks, Mortgage Companies, 6-figure Non Profit Poverty Pimps were all in on the act. Lawyers were suing Banks for racist practices and the same law firms were defending Banks for other matters. People were playing both sides. Deval Patrick was fighting for minorities for the NAACP and got political power being connected to the Clintons, and then when Bush becomes President, he goes off and makes money on the Board of Ameriquest, a private sector mortgage company that preyed on the minorities. The players in both the public and private sector were rotten. At this point we didn't even have lawmakers making the law, it was the special interests, the politicians delegated the actual policy making to the lobbyists and many never even bother reading what they were voting on. The structural integrity of these leaders were mush.

The argument at the time went like this: "You don't want poor people to own a house" versus "No, I just can't lend to someone who hasn't had a steady job or has a down payment so if the place gets foreclosed on I lose money". At this point, if there was no subsidy the poor couldn't afford a home and perhaps you would have seen a larger percentage of renters versus owners in our society and that might not have been a great thing. Maybe, however, prices may have had to come down to affordable levels? What trumped all of this was that the bleeding hearts got their poverty pimp jobs and the haliburton types got theirs, and the risk went to the responsible. What is sad is that many of these policies had the right intention and maybe made society better than what could have been the alternative. I think having professionalism, or having certain roles requiring integrity to be held by licensed professionals as opposed to the sleazebags who ended up being mortgage brokers, etc. might have created a stronger infrastructure to have held this together.

I guess I'm a lot cynical. I do believe that you have to balance governance to the world you live in with the world you want to be like, but I believe that staying true to your core values helps build the load bearing integrity to take on more load and more capacity to do more good. I think a lot of sleazebags screwed up a really nice vision of broad based homeownership. I see Republicans as seeing the world as it really is, and I see Democrats as seeing the world as they hope it to be, I think you really need both. I think Patrick and Obama are in trouble because they made these flowery promises, yet their excuses for not getting them was that they "understimated the bad situation" i.e. didn't see the world as it was.

I think statescraft today is about gauging values and aspirations with real world limitations and much of it has to do with speed. For example, if we can open trade up to a society that shares our values, tells the truth, doesn't have copyright infringement, has a stable currency and enforcement of rules and business models and contract law similar to ours, well then, shit we can quickly get trade going. If we have serious gaps in one are, then maybe we ought to take things a little more slowly and build little by gradual and not get too dependent on a society that isn't as stable. We all bought the oil, bought the SUV's, bought the I-pods, flat screen t.v.'s etc. so we all acclerated the trade deficit. Part of today's statescraft is communicating to the individual, their contribution to our problems. Many don't want to do that because it will alienate voters. I mean how well does it go over with a voter if you say, "Hey, you guys sent your wealth to China every time you bought one of your gadgets and when you did that you took away jobs in the USA". What happens when you say to the yuppie couple, "Hey, you won't live in Brockton or Lynn because you don't want to live among the poor and deal with their issues, and how can we heal as a nation if the rich and poor live segregated?" That wouldn't go over very well, and the Press isn't going to ask those sorts of questions either, so we don't address certain issues that bridge the world as it exists versus the world we hope to live.

[mpr]