Housing Bubbles
How can we explain why housing prices have risen so much 2000-2005 relative to
stock prices? Will prices fall? Maybe not, if the reason is low interest rates. Let
me explore the idea.
Suppose many people cannot borrow. First, let us suppose it is because no banks
exist. Many people who would like to buy houses using their future income can’t, so
house prices will be low. Then, unexpectedly, banks start to exist and make loans.
House prices will rise dramatically, and will stay high. Suppose, then, that the
banks all disappear, and no new loans are issued. What happens to housing prices?
Demand for houses will not grow as fast as in the past— since potential new
homeowners can’t get loans— but it won’t fall either. So there might be no effect
on house prices. Prices will rise when banks appear, but not change when banks
disappear.
Would that same argument work (if it does work) with interest rates falling
instead of banks appearing out of nowhere?
April 23rd, 2006 at 5:56 am
I know that we were, a year ago, renting a small house for $550 a month. We were looking to move to a larger house, but we had no money for a downpayment. So, we were thinking about renting a slightly larger house. As we were looking, we found a house that was twice as big as the house we were in, but it was for sale, not for rent. On a whim, we called the real estate agent, he asked us a few questions, and the process started. We ended up buying the house with no downpayment, and our mortgage payment is significantly less than it would have been if we would have rented a house of the same size, and only slightly more than our old rent. So, in our case, the low interest rates changed us from home renters to home buyers.
May 4th, 2006 at 11:51 am
If banks disappeared, then the price of houses would fall, because demand would fall. The price of houses is set at the margin by the last buyer and seller. With no banks, potential buyers couldn’t get credit. However, exisiting owners also couldn’t get credit to “trade up” to better housing. I suppose the only those wishing to “trade down” or switch to renting wouldn’t need a bank. But in that case, they are trying to sell a (previously) more valuable home in exchange for a smaller home or no home. In either case, it seems that supply grows relative to demand, and prices fall.
I expect an increase in interest rates to effectively reduce demand for housing in the U.S. More importantly, I’m guessing that any curtailing of “exotic” mortgages, such as interest only or negative amortization, will be far more important than interest rate increases in squelching demand.
September 7th, 2007 at 7:26 pm
I found your blog via Google while searching for interest rate future and your post regarding Bubbles | Eric Rasmusen’s Weblog looks very interesting to me.
May 9th, 2008 at 6:03 pm
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