ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

[karim0028]

http://www.zerohedge.com/article/gue...+drops+to+zero)

Some points to consider for those so stuck on realestate....

My last post Correlation of mortgage rates with real housing prices: how increasing inflation could affect housing prices, raised some questions. I didn't have the chance to respond to them.

But before I do, let me go back to the original purpose of the article. I asked the question, "What could happen to real estate in the event of higher inflation?" If inflation shot up from 1% to 7%, what would happen to the real value of your home. My thesis was: you're screwed. You will lose what little equity you have and real housing prices could drop by as high as 50%.

This was in contrast to the central thesis of the book Irrational Exuberance by Robert Shiller. His book included a chart which showed the relationship between home prices, population growth, building costs and interest rates. His chart seems to suggest that housing prices have little correlation to the interest rate. This chart was misleading and hides the real relationship between interest rates and housing prices.

[FRED]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

http://www.zerohedge.com/article/guest-post-correlation-mortgage-rates-real-housing-prices-ii?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed:+zerohedge/feed+(zero+hedge+-+on+a+long+enough+timeline,+the+survival+rate+for+ everyone+drops+to+zero)

Some points to consider for those so stuck on realestate....

Why not post our scenario over there?

Inflation is Dead! Long Live Inflation!

The Five Year, 100% Inflation Scenario

by Eric Janszen (from AlwaysOn Network, December 29, 2005)

Five-Year 100% Inflation Scenario

A 100% inflation over five years might look as follows to a household that in Year Zero has an annual income of $100,000 and a fixed rate mortgage balance of $400,000 on a house valued at $500,000.

In the model, inflation peaks at 35% in Year Three. If 13% of income is paid annually toward the mortgage at the start of the period, at the end of five years the fixed mortgage cost falls to 6% of income and the mortgage balance represents 16% of the value of the home versus 80% at the start.

If the homeowner increases his annual payments to adjust to 13% of income over the five-year period as nominal income rises, the amount paid in increases such that at the end of Year Five the mortgage balance has been reduced from $400,000 to $171,692. That's many years of normal debt payoff condensed into a few years.

Five-Year 100% Inflation Scenario

A 100% inflation over five years might look as follows to a household that in Year Zero has an annual income of $100,000 and a fixed rate mortgage balance of $400,000 on a house valued at $500,000.

In the model, inflation peaks at 35% in Year Three. If 13% of income is paid annually toward the mortgage at the start of the period, at the end of five years the fixed mortgage cost falls to 6% of income and the mortgage balance represents 16% of the value of the home versus 80% at the start.

If the homeowner increases his annual payments to adjust to 13% of income over the five-year period as nominal income rises, the amount paid in increases such that at the end of Year Five the mortgage balance has been reduced from $400,000 to $171,692. That's many years of normal debt payoff condensed into a few years.

[karim0028]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

I hadn't seen this before; before my time here at itulip... There is a column mentioned; which column is that? BTW, i usually read all my blogs/daily readings through RSS (hint hint;)) and rarely go to the sites so i will dig around ZH to see if they have a forum or post this article at least in their comments ;)

[FRED]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

I hadn't seen this before; before my time here at itulip... There is a column mentioned; which column is that?

The title Inflation is Dead! Long Live Inflation! is also a link that you can click on.

[shiny!]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

FRED, would 100% inflation over five years be considered hyperinflation?

[Jay]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

I think I remember seeing a post here once that in Argentina, after the devaluation of the peso, mortage contracts were re-written to reflect the devaluation of the currency. I.e., the amount you owed was adjusted upward as the currency was ratcheted down. Can anyone confirm this?

If this is true, it may have ramifications when thinking of buying a house using leveraged debt going forward and hoping that a seventies style stagflation will make you richer as the value of that mortgage debt is inflated away. And, yes, when it comes to banana republics, we are not Argentina in the US yet, but we are doing our best! I never thought GM bond holders would take a back seat to the union, and that happened, so all bets are off going forward when it comes to "iron clad" contracts.

[FRED]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

FRED, would 100% inflation over five years be considered hyperinflation?

No. The standard definition (e.g., Deloitte Touche) is above 100% in a single year. Major industrial economies, such as Korea's during the 1950 and 1960s, operated at 40% annual inflation for long periods without ill effects. FIRE Economies, however, cannot operate with such high inflation rates. Today India's inflation in in the low teens.

[karim0028]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

I think I remember seeing a post here once that in Argentina, after the devaluation of the peso, mortage contracts were re-written to reflect the devaluation of the currency. I.e., the amount you owed was adjusted upward as the currency was ratcheted down. Can anyone confirm this?

If this is true, it may have ramifications when thinking of buying a house using leveraged debt going forward and hoping that a seventies style stagflation will make you richer as the value of that mortgage debt is inflated away. And, yes, when it comes to banana republics, we are not Argentina in the US yet, but we are doing our best! I never thought GM bond holders would take a back seat to the union, and that happened, so all bets are off going forward when it comes to "iron clad" contracts.

I have a hard time believing the Supreme court would allow retoractive contract re-writes... We may be heading to a banana republic, but that would really get the pitch forks out... It would kind of defeat the purpose of devaluation, get the balance sheets straightened out.

[BK]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

I'm not getting your example - if this Fictitious Homeowner lives on the the Northeast or West Coast and has children - where will the additional 13% come from to pay down the Mortgage. Cost for food, clothing, Taxes and fees, water, electric, heating, and gasoline will be rising with Inflation - Correct.

Comparing the 1970s with today - in the 1970s many more Workers were Union employees and covered by Union Contracts that may have guarantee a CPI increase in Wages - this is Not the case today.

Am I wrong in assuming there are many homes owners don't have an additional 13% to throw at the Mortgage?

[jneal3]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

I'm a little lost with this thread, I've been under the impression that the inflation coming our way is inflation in all the things we don't want to see it in (staples, imports, energy) and not in any of the things that would help (home prices, wages). The difference this time around versus the 70's is the contraction of credit, which along with the surplus of housing and unemployment will keep housing prices from inflating.

Or I'm just another engineer without an economic clue.

[karim0028]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

I'm a little lost with this thread, I've been under the impression that the inflation coming our way is inflation in all the things we don't want to see it in (staples, imports, energy) and not in any of the things that would help (home prices, wages). The difference this time around versus the 70's is the contraction of credit, which along with the surplus of housing and unemployment will keep housing prices from inflating.

Or I'm just another engineer without an economic clue.

I will let EJ or FRED answer as to the itulip position on this, bc i am also confused on itulip position on RE.. I believe i saw it somewhere where EJ mentions that its likely to decline by a certain amount (hint: go check out the book)... My view (largely shaped by EJ's writing), and take it worth a grain of salt since i am obviously not EJ, is that if RE appreciates at all it will appreciate nominally, but in real terms will still deflate. This hinges on if incomes inflate inline with inflation as well... If income doesnt inflate or inflate enough, then, i cant see how anyone would be able to afford inflated prices.

When interest rates rise, gas/electrical prices rise, food prices rise, house affordability goes down (as far as i can tell; its a zero sum game); how can people afford it? The big question here is how high of inflation and how incomes match with inflation.... If we get 30% inflation/yr as EJ states but incomes only go up 10-15%/yr then that could be a limiting factor.... A currency crisis i believe would put a damper on asset prices relative to the outside (non-dollar) world.

Unless we go Weimar, i cant see folks getting a raise ever month or so (but then again i wasnt alive in the 70's, so of this im not sure how the job market would be at that time). I guess the easiest thing we could do is look at countries that have had currency crisis; what happened to their asset markets, they may have gone up nominally, but still been seriously depressed relative to other countries/currencies... ie. if your monthly gasoline expenditure goes from 100/month to 500/month and then you get a raise of 300/month; are you really better off? Your still getting poorer...

But, then again i would like EJ's opinion on possible outcomes on RE in particular, bc there are so many damn variables at play here. If real incomes dont rise, real house prices cant rise. EJ is predicting an inflationary depression, and depressions dont usually come with big raises and living standard increases... Numbers can get bigger but be worth less. All i know is that i cant fathom 16-24% interest rates being good for house prices... 16% on 100K is 16K/yr in interest alone... I pay 750.00/month rent on a 2 bedroom condo (close enough to my office i could throw rocks).... If someone can explain how that would be; please do....

[loweyecue]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

I'm a little lost with this thread, I've been under the impression that the inflation coming our way is inflation in all the things we don't want to see it in (staples, imports, energy) and not in any of the things that would help (home prices, wages). The difference this time around versus the 70's is the contraction of credit, which along with the surplus of housing and unemployment will keep housing prices from inflating.

Or I'm just another engineer without an economic clue.

This was my understanding as well. Count me in the clueless group.

[loweyecue]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

Also why would I pay 13% more in today's higher valued dollars as opposed to paying that down the road after my debt has been devalued by inflation? If I pay more now doesn't the real value of the house go down even further for me?

[karim0028]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

Also why would I pay 13% more in today's higher valued dollars as opposed to paying that down the road after my debt has been devalued by deflation? If I pay more now doesn't the real value of the house go down even further for me?

Well, i think thats kind of the hitch Debt is paid over time, inflation eats away at debt; at the benefit of the debtor against the lender... But, there are lots of variables that are IF's... As far as i can tell, you would lose on the portion you put as a down payment when the currency was stronger; which could have been invested in gold or silver or something else that would appreciate against a depreciating dollar.

IF incomes dont rise with inflation and the interest payments at the time are high (due to a currency crisis) then some one who owes benefits; but someone who comes to buy, either cant afford the loan or has enough cash on hand to pay; ie. house prices should stagnate to where some folks can pay cash... If no bank is willing to loan due to high inflation then i would think those with cash and liquidity could scoop in and buy outright...

There is also the political aspect, if rates are high and govt comes in and does an interest rate subsidy (as i understand they did in the 80s) that could bouy up the housing market....

[tacito]

Re: ZeroHedge - Correlation Of Mortgage Rates With Real Housing Prices II

I think I remember seeing a post here once that in Argentina, after the devaluation of the peso, mortage contracts were re-written to reflect the devaluation of the currency. I.e., the amount you owed was adjusted upward as the currency was ratcheted down. Can anyone confirm this?

If this is true, it may have ramifications when thinking of buying a house using leveraged debt going forward and hoping that a seventies style stagflation will make you richer as the value of that mortgage debt is inflated away. And, yes, when it comes to banana republics, we are not Argentina in the US yet, but we are doing our best! I never thought GM bond holders would take a back seat to the union, and that happened, so all bets are off going forward when it comes to "iron clad" contracts.

I don't know the Argentina case, but maybe they were mortgages in USD when they currency (peso, austral?) was linked to the dollar.