Wednesday, June 29, 2005

Interest rates and house prices

Another great post from CR (on Angry Bear) about the housing bubble. It's not obvious if high or low interest rates should have any impact on the price of housing. On the one hand, if interest rates are low, then the present value of future rents that house would producde are higher, so the value of the house should go up. On the other hand, does your broker's margin rates really impact whether you think is worth buying at $300 or not?

The post notes that historically, house prices and interest rates have been fairly unlinked, but household income and prices correlate strongly. If households are only looking at their ability to make monthly payments, then they are becoming seriously over leveraged. This means that they are more likely to foreclose on their home if their personal situations deteriorate and they owe more money on the house than it is worth.

So, if banks experience a larger than expected number of defaults on their home loans, who will pay? I'm guessing the tax payers via Freddie Mac/Fannie Mae. (Update It seems that MA, one of the most frothy bubble markets, has seen defaults increase).

Update winterspeak reader JT writes in arguing that
It's true that defaults have increased this year in Massachusetts, but I expect that the data is a bit difficult to read because of the massive increase in bankruptcies due to the change in bankruptcy law. (The new rules, which make it harder for people to protect certain income and property, were passed with a six month period until they phase in.)

See here, for instance:

Bankruptcy filings jumped 60% in March and April compared to January and February, and almost surely as a result of the bankruptcy law and people trying to beat the changes. This makes it hard to rely on foreclosure stats, due to this confounding factor.
That's a great point and I think he's right. I don't think this wave of foreclosure is not caused by overleveraged homeowners because interest rates have not moved yet. It also suggests that bankrupcy fraud was more widespread than some may have thought.


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