I'm not an economist. In fact, I've never even taken a course in economics, but it doesn't take a rocket scientist to know that the housing market is in a bubble when banks are giving "interest-only mortgages."
Perhaps we should give attention to Princeton economics professor Paul Krugman's warning to "Beware the real estate bubble."
3 comments:
When this bubble bursts it will be devistating. And everyone will look around and say how did that happen.
Interest-only mortgages have been around for a long time. For some they actually make sense. For example, if one has $200,000 to buy a home and not have a mortgage or use 20% of the money for a downpayment and invest the rest at 10-15%, it makes sense to make interest-only payments at five or six percent. For most, however, they make little sense. I work in the mortgage industry, selling mortgages. Many who ask about the IO products are merely seeking the lowest payment possible. They are not the wise investors who would rather earn 15% and pay 6%. I can think of only one time in the past few years that I actually recommended an IO loan. The borrower was elderly and still owed on her home. An interest-only mortgage increased her cash-flow significantly. She had no interest and very little likelihood in paying off the home anyway.
It is nigh unto impossible to have a national bubble in housing prices. The simple reason is the price of houses in, say, Los Angeles has no bearing on housing prices in San Francisco. In fact, the housing prices in a particular Los Angeles suburb has no bearing on the prices in another Los Angeles suburb. There are plenty of regional bubbles that may (and probably will) burst, but this will likely happen one region at a time. (When I speak of "regional" bubbles, I am limiting a region to a small area. Do not think "East Coast;" think "specific suburb/exurb".) Of course, if a large percentage of the regional bubbles burst the net effect will be as if there were a national bubble but there is little reason to think this will happen all at once. It is likely that we will soon see home appreciation taper off to level for a few years. Most of the bubbles occur in new developments and "trendy" neighborhoods. A coworker recently sold the modest home his father left him for $1,000,000. The buyer promptly leveled it to build his dream home. It was the only home (read "lot") for sale on the small lake (the lake is in the middle of a large city). It is this sort of behavior that is driving many of the bubbles.
The other big factor (this is in answer to the question that Greek Shadow commented will be asked) that is causing the bubbles is speculation. With interest rates still very low, it is less costly for many to buy homes with the idea that the home will appreciate rapidly and can be sold in a short time for a large profit. Many have been getting wealthy by doing this over the last few years.
what makes a mortgage affordable is not how low thee rate of interest is, but the differential between present and future values of debt. that is why, in a lot of parts of the world, mortgages were more affordable in the 70s, even though interest rates were higher (often double what they are today), because the effect of infation was to erode the actual value of the debt. if you have double digit inflation over a decade, then the actual principle of the debt shrinks in real terms.
interest only mortgages can work in infationary situations, because the inflation hits the principle for you, or in situations where there there is sustained and dramatic increases in property prices.
i'm not sure about the situation in the US, but certaily in the UK and Australia there have been serious property falls (the central london property market has been falling since 2001) and there is no economic reason to assume major US cities will be immune to this.
the indicators you might want to look at are the current house price to income ratios compared to historical averages (in both the UK and Aus these were at record highs), and mortgage payments as a percentage of household income (this tells you how much people can absord interest rate rises).
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