The housing market depends entirely on interest-rate stimulus

Without affordability products the housing market depends on low mortgage rates for sales to occur at today’s high prices.

Back in February of 2013 when mortgage rates were near record lows, I wrote that future housing markets would be very interest-rate sensitive, despite assurances to the contrary from most macro-economists.

The prevailing economic view is that the housing market would respond positively regardless of what happens with mortgage rates because house prices in the past have correlated poorly with mortgage rates. For example, during the 1970s, interest rates rose significantly, which should have caused house prices to drop, but instead California inflated a housing bubble. During the crash from the bubbles in the 1990s and the 2000s, interest rates declined, and so did prices.

Since the market went through significant periods when prices moved in opposition to mortgage rates, and since macro-economists aren’t skilled in deciphering the reasons behind their models, they failed to recognize that the new mortgage rules changed the way housing markets work.

According to the theory I postulated back in early 2013 — prior to the rate surge from 3.5% to 4.5% — rising mortgage rates should cause sales volumes to fall and falling mortgage rates should cause sales volumes to rise. The restricted inventory may cause prices to go up, but the changes in affordability caused by mortgage rate fluctuations would necessarily impact sales volumes by pricing out (or pricing in) marginal buyers.

In October of 2013 after the sudden mortgage rate spike pummeled sales, I wrote about the mounting evidence of the market’s sensitivity to mortgage rates.The mechanisms used to inflate previous bubbles — using teaser rates, allowing excessive DTIs, and abandoning amortization — these were banned by the new residential mortgage rules. Lenders can’t soften the impact of interest rate fluctuations or provide “affordability” when the market reaches its friction point. This is the main reason the market changed so dramatically and so suddenly when mortgage rates surged.

The final piece of evidence supporting the mortgage sensitivity hypothesis just fell into place: falling mortgage rates is causing a late-season improvement in sales as marginal buyers who were shut out of the market until just recently suddenly found themselves able to finance the amounts necessary to afford today’s high home prices.

Southern California’s home sales hit 5-year high, but low end doesn’t look so good

By Gregory J. Wilcox, Los Angeles Daily News, Posted: 10/13/14,

Southern California’s housing market gained momentum in September as sales hit a five-year high for the month and increased from the year-ago level for the first time in a year amid continued moderating price increases, a market tracker said Monday.


Last month sales of new and previously owned houses and condominiums increased 1 percent and the median price rose 8 percent, according to CoreLogic DataQuick.

The slight sales bump was driven by increased activity at the mid-to-high end of the market, the company said. …

Before last month’s gain, sales had fallen from a year ago for 11 consecutive months, CoreLogic DataQuick reported.

September home sales have ranged from a low of 12,455 in 2007 to a high of 37,771 in 2003. But last month’s total was 18 percent below the September average of 23,695 sales since 1988.

This is a glass half-empty debate. Sales volumes are certainly up from the 2007 lows, but they are down significantly from the long-term average. Is that good or bad? Perhaps we should call it bad but improving?coastal_california_fall

CoreLogic DataQuick analyst Andrew LePage said that September’s small sales increase by no means signals a market turnaround.

We still have some summer activity closings, so I wouldn’t read a whole lot into September,” LePage said. “We’ll see what happens over the next couple of months.”

The activity over the next few months will depend on what happens with mortgage rates. If they continue below 4%, sales will be up; however, if rates rise back up above 4%, sales will dry up again.

“Price appreciation has dipped into single-digit territory as more would-be buyers get priced out, investors back off and incomes rise modestly at best,” LePage said.But upward forces on home prices are still in play.

Mortgage rates impact sales volumes by pricing out or pricing in marginal buyers.

“Jobs are being created and families started at a time when the supply of existing homes for sale, as well as the number of new homes being built, remains relatively low,” he said.

Potential buyers are still benefiting from low mortgage rates, and the market is past the peak home-buying season, so there should be less competition for properties.

The LA Times wrote a similar story last week, but didn’t mentioned the real reason for this late-season improvement: falling mortgage rates.


This sales improvement is not due to an improving economy, nor is it due to surging employment or rising wages. It’s a small bump in sales due to low mortgage rates — a bump primarily concentrated among properties at above-median prices.

In my opinion, the combination of low rates and less buyer competition makes this fall a good time to buy. In the past, I would have been more concerned that rising mortgage rates would cause prices to fall, but with cloud inventory restrictions still in effect, if affordability falls, so will sales volumes, but prices will remain high until either rates drop again or wages catch up.

It’s harder to smooth out interest rate fluctuations

With the normal mechanisms for smoothing out interest rate fluctuations banned, house prices and sales volumes will be dictated by the course of interest rates. It’s widely believed mortgage interest rates will rise in the future. I recently asked What will a long-term rise in interest rates do to home prices? Based on what we’ve seen over the last few months, we can expect sales volumes to plummet when interest rates rise, and if they rise high enough, price pressure will mount. We won’t see a crash without must-sell inventory, but we may see air pockets where prices drift lower as discretionary sellers decide they want to get out.

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