Some commentators seem to think that plummeting housing prices are the enemy. But weren't plummeting prices (i.e., a market correction) inevitable and necessary?
Starting in 2001-02, U.S. housing prices began to artificially inflate, like stock prices did during the tech-stock bubble. Eventually (unless people's salaries go up at the same rate as housing prices, which they haven't), the housing bubble had to start deflating because the economy can't sustain artificially high prices forever.
I'm not an economist, but it seems to me that the Fed's keeping interest rates artificially low for too long is what caused housing prices to artificially skyrocket.
In my North Florida town, for example, a house that might have sold for around $175,000 in the year 2000 ended up selling for $250,000 or more in 2004-05.
Most people's salaries did not go up that fast. The only reason many people could afford a $250,000 house is that interest rates were so low, enabling them to make the monthly payments if they stretched the mortgage out 30 years.
Those who got fixed interest rates probably still can afford their monthlies. Those who got Adjustable Rate Mortgates (ARMs) could afford the payments until the interest rates started adjusting upward (i.e., back to a normal level).
To give you an idea of how interest rates affect monthly house payments, I've constructed the table below (based on a Wachovia mortgage calculator for a 30-year mortgage on a house in Florida that's actually worth $200,000).
Loan Interest Rate Monthly Payment
$200,000 4.5% $1,013
$200,000 5.5% $1,135
$200,000 6.5% $1,264
$200,000 8.0% $1,467
People who can afford the monthly payments for a 5.5% mortgage might not be able to afford the payments on an 8% mortgage.
From about January 2001 - June 2003, the Fed cut interest rates 13 times, partly in response to the dot-com bubble and the 9/11 attacks. The initial cuts might have been good for our economy, but keeping interest rates low for so long drove up housing prices beyond reason (i.e., beyond what most people could afford while paying a more natural interest rate).
My fear, assuming that I understand the situation correctly, is that policy makers might opt for going back to cutting interest rates for the long term. l
If mortgages become cheaper again (and for a long time), then won't housing prices simply remain artificially inflated or become even more so?
If that happens -- unless most American's salaries inflate similarly, which I wouldn't bank on -- most Americans won't be able to afford houses down the road.
That might be nice for people who bought houses at artificially inflated prices, but what about everyone else? And how would that affect the building industry and other connected industries -- along with the many jobs attached thereto?
Memeorandum has other commentary.