Tuesday, September 11, 2007
Over the past half century, every U.S. housing downturn as sharp as the current one has translated into a U.S. recession. U.S. house prices are falling at an annual rate of nearly 4%--an event not seen since the Great Depression--and the downward trend is accelerating.I am no macroeconomist, but my pet theory for housing prices is that prices are based upon what people can afford per month. I don't think too many people purchase homes with cash, they get a 30 year mortgage. For example: Say a worker can afford $2,000/month on a mortgage. If the interest rate is 5% then he can afford a $372,000 loan, if the interest rate is 10% he can afford only a $228,000 loan. When interest rates are low, people can afford bigger loans and so they bid-up the prices of houses. When the rates are high, fewer can afford houses and sellers must accept lower prices.
The standard view on interest rates is that, once you account for inflation, the rate depends on the demand for money. When an economy is strong there are lots of good opportunities available and the demand for capital is high, which drives up interest rates.
Could a strong economy have in it the seeds of its own downfall? Yes, this is why macro always did make my head spin.