On a Housing Crisis

I've read quite a bit about the recent credit crunch, and it usually leads me to contemplate the state of the US economy (I hear much of the same is happening in Western Europe, but I can only really account for what I see and know). I've studied the most on what is happening (on a macro scale) in the US housing market. Every time I see that the Federal Reserve lowers its discount rate to stave off some recession, I just have to shake my head. So much of what is happening now is a result of the unbridled growth in the Housing Market thanks to very cheap money.

What tinkering Central Banks seem to not realize is that the very things we are fighting to stop a recession were the result of low-cost money through low-interest and eventually unwise investing. Many forget that interest rates are the product of a free market, and that tinkering with that interest rate can have serious consequences. An interest rate is the bargaining equilibrium between savers and spenders. That rate represents the crossroads between future preferences versus present preferences. The savers (who have future preferences and must be paid to lend that money--interest rate.) and the spenders who pay that interest rate so that they may have their money now. When this interest rate is manipulated, mainly through Central Banks, this can throw a market off-balance to favor either the buyer or the seller.

We can see just why housing prices rose the way they did from the availabilty of many loans with little collateral to ensure a good investment loan. With different sorts of lending packages and investment vehicles, the last few years saw a very quick rise in house prices due to availability of money, cheap money that is. The interest-only loan, which only demand payments on the interest, not the principal, gambles that the price of the house will increase to profit from the purchase. For years, those housing prices increased with little abatement. Now that the credit machine of the United States (and a lot of Europe) has seized up, these homeowners can no longer count on a quick turnover of their investment. The problem with interest-only loans is that they mature and after a said amount of time demands payment of both interest and principal, something many homeowners cannot afford. This crowding up of sellers means now prices must fall.

As the Economist so adroitely pointed out, housing prices tend to be very sticky. Homeowners are not very quick to drop the price of their homes, many times because of stubbornness, but unfortunately also because they simply cannot afford to take the loss, that is if there is a buyer to sell to. We were able to sell our condo before this housing market went so sour. My wife and I had purchased a home, with no money down and with a nice mortgage payment from an interest-only loan. After a few months, we found we could no longer afford to live there presently, and we would certainly have foreclosed if our payment had included principal. We were lucky enough to sell our place and actually still made a nice profit. Many who are in the same circumstances now are not as lucky as my wife and me.

The Fed can lower interest rates, and there may be somewhat of a recovery, but that does not mask what has really happened: inflation in the housing market. When housing prices stop rising, there is less of an incentive to get an interest-only loan, so we should see less of those. As houses sit on the open market, a downward correction must occur to bring the housing market back to an equilibrium. Treasury can delay many loan maturities, but those loans have to mature sometime. What are we going to do then? These prices cannot stay this high and continuing to artificially inflate those prices, it just means that we have that much further to fall. A correction is needed, the longer it is delayed, the worse it will get. Let's wait and watch.