Thursday, December 4, 2008

Follow Up On Treasury Plan To Lower Mortgage Rates

Here are some thoughts in response to yesterday’s story that the Treasury is considering a plan to push mortgage rates to 4.5%

Andrew Jeffery writes for Minyanville Treasury Tries To Re-Inflate Housing Bubble

…This is the latest in a series of botched attempts to re-inflate the housing bubble. And like the others before it, the plan fails to address the root causes of ongoing home price declines: Negative equity, over-supply and mounting job losses.
The flood of recent loan modification programs championed by FDIC Chairman Sheila Bair and rolled out by JPMorgan (JPM), Citigroup (C) and Bank of America (BAC) also miss the point. Like any distressed market, the housing market badly needs price discovery. And like any other asset class, the true price of a house is only discovered when someone buys it on the open market.
By creating unnaturally low interest rates and allowing buyers to purchase bigger homes than they could normally afford, Paulson and Bernanke are preventing home prices from falling back to where responsible, fiscally minded Americans can buy without the crutch of government subsidies.
These continued distortions of the free market end up running in contrast to their intended goals: As long as the charade continues, as long as the real estate market is prevented from finding a natural bottom, home prices will continue to fall.

CR writes for Calculated Risk:

The WSJ article correctly noted that lower interest rates "increas[e] demand for homes", but do they push up home values? The answer in the current environment is probably no.
This may be a little surprising since lower interest rates will likely increase demand.
In a perfect market, an increase in demand would push up prices. And an increase in supply with steady demand would lower the price enough to clear the market.
However, housing is an imperfect market - house prices are sticky downwards and typically take several years to adjust (what we are seeing!) - so even though there is currently far too much supply, prices still have not fallen far enough to balance supply and demand.
An increase in demand from current renters deciding to buy, would probably only make a small dent in the huge excess supply. And house prices would continue to fall - so the goal of supporting house prices would not be met.
In fact, it could be worse. Landlords, already struggling with high vacancy rates and falling rents, would probably lower their rents further and make the rent vs. buy decision more difficult again. So lower interest rates might not boost demand very much, it might just lead to lower rents.
This is a bad idea from the Treasury. And leaking this story is a terrible idea, since some potential homebuyers might potentially wait for lower interest rates.